The stock market sell off that began three weeks ago intensified early this week, as the S&P 500 Index fell nearly 10% off its all-time high Tuesday before closing above the low. Stocks are suffering the most severe pullback since the second half of 2023, when the S&P 500 fell 10.6%. The difference between then and now, is that the sharp sell off has happened more quickly. In 2023, the correction played out over three months, instead of three weeks.
That can have a much greater impact on an investor’s mindset. We want to give you two ways to deal with that.
Strategy #1: Stay Invested
No matter how much fear sets in that you need to jump off the roller coaster, history tells us it would be a bad idea. This kind of volatility is normal.
According to LPL Research, pullbacks of 5-10% happen, on average, three times per year. Even a 10% correction is common, happening, on average, once every year.
The maximum drawdown for the S&P 500 has averaged about 14% per year since 1980. In years of positive returns, the average maximum drawdown is still 11%.
We didn’t get one in 2024, but we got one in 2023. It is the price we pay for long-term growth. And we may pay a bigger price if we jump ship.
The Cost of Jumping Ship
LPL tells us the S&P 500 has gained an average of 9.8% annually since 1990. If you missed the best day of each year, your return drops to 6.1%. Miss the two best days of each year, and your return would’ve been just 3%. The biggest up days tend to happen when the Index is below its 200-day moving average.
And lastly, since 1980, after corrections, the Index has been higher on average 13.1% three months later, with gain 92% of the time. That’s off the low, which we won’t know for a while when that it.
Volatility is the price we pay for long-term growth.
Strategy #2: Build a Diversified Portfolio
Investors should not be all in on the S&P 500. Of course, the index cannot be directly invested into, but lots of investors put everything into index funds that track the performance of the Index. The S&P 500 is a weighted index, meaning the largest companies in the Index can carry it. Those larger companies have been hit hard in the past three weeks.
A diversified portfolio, spreading equity risk across multiple sectors and styles, and adding in bonds, alternatives, and even cash, can dampen volatility. It can also create more wealth.
The Power of Diversification: A Case Study
Take a look at this chart. This tracks a $1 million dollar diversified portfolio, in black, compared to $1 million tracking the S&P 500 Index, in green, from 1999 to 2020.
You can see the diversified portfolio grew to $3.5 million versus $3.2 million in the S&P 500. The key reason is that it didn’t take the severe dips when the bear market came, and took less time to recover because of it. Past performance is no guarantee of future results.
Bottom line, preparing your portfolio before the market volatility comes, and weathering the storm during it, is the best way to work toward your long-term financial goals
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Independent Advisor Alliance. Independent Advisor Alliance and GenWealth Financial Advisors are separate entities from LPL Financial.
