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Surviving Volatile Markets

April 26, 2022

Market volatility and even bear markets and downside corrections are the price we pay for the long-term positive returns one receives from the investment markets. Literally, Harry Truman’s admonition applies to investing: “if you can’t stand the heat get out of the kitchen.”

What can make the “heat” more bearable is knowledge and an understanding of how markets work.

First, we look at Nobel Laureate Harry Markowitz’ Modern Portfolio Theory (MPT). This relates to diversification and could even be summed up by the old adage of not putting all of one’s eggs in any one basket. More specifically, related to diversification is that you should be investing in non-correlated asset classes – meaning they all do not move the same way at the same time. Thus, when we look at equities this year we see them largely having moved downward. The same could be said for the fixed income (bond) markets thanks to inflationary pressures and the Fed raising interest rates.

Has anything increased in value during this time? One could look at securitized real estate (stocks providing ownership in RE) and within this asset class, sub classes that have done very well in response to the current environment. Which of course proves MPT – that if one is properly diversified there will always be some asset classes moving upward while others down. In the long-term Markowitz proved that following the tenets of MPT one should tend to have increased expected returns concurrent with expected lower volatility.

If it will help better sleep patterns in these volatile times, one should take an historical view of investing. The below thanks to our friends at DFA:

“Annual stock market returns are unpredictable, but “up” years have occurred much more frequently than “down” years in the US. That may be reassuring to investors, especially if they find market downturns unsettling.

  • The US stock market posted positive returns in 75% of the calendar years from 1926 through 2021.
  • The market gained an annualized average of 10.2% during this period. Yet nearly two-thirds of yearly observations were at least 10 percentage points above or below the average.
  • Another noteworthy trend: More than two-thirds of the down years were followed by up years. The most recent example: a 5.0% loss in 2018 followed by a 30.4% gain in 2019.

The stock market tends to reward investors who can weather annual ups and downs and stay committed to a long-term plan.”