Bob French, CFA

Black Monday Is Not a Black Swan

Last Monday, the S&P 500 dropped by more than 3.5%. This is a big drop, and has a lot of folks wondering if they should be invested in the market at all. It’s easy to get wrapped up in media coverage, and not keep last Monday in perspective. It was a bad day, but historically, we see something like last Monday a little less than twice a year.

Putting “Black Monday” In Perspective

We went back and looked at the daily returns of the S&P 500 Index from January 1, 1926 to June 30, 2015 – almost 90 years of market returns. During that time period, there were 164 days with returns worse than the -3.66% drop we saw last Monday. So, on average, we saw a day at least as bad as “Black Monday” almost twice a year. I wouldn’t call that common, but I wouldn’t necessarily call it uncommon either. About 1.28% of all of trading days in our analysis actually had returns below -5%. While a “Black Monday” equivalent happens about twice a year, something worse happens a little less than once a year.Putting Last Week's Market Drop in PerspectiveWe can slice and dice the daily numbers a thousand different ways, but the end result is the same: big daily moves are more common than most people think. If we look at the chart above, the two red vertical lines enclose the area within two standard deviations from the average. If you’re a little rusty on your statistics, that means about 95% of the time we’ll be somewhere between those lines. It also means that one out of every 20 days, on average, we’ll be outside of those lines. So about once every four weeks, we’re going to see a pretty big move one way or the other.

Stop Worrying and Learn to Love the Market

So what does all of this mean? How can you deal with all of the day-to-day swings of the market? The first thing to do is simply not pay attention to the daily moves. It’s just noise. Focus on the longer term perspective. If you consider the same time period, January 1926 to June 2015, the S&P 500 Index had an annualized return of 10.07%. So a single dollar invested in 1926 would have grown to $5,378.37 at the end of June, despite all of the noise.

The key to investments is consistency. In our weekly email last week, we highlighted an article about the worst market timer in the world. He invested right before some of the major down markets in the history of the market, but he actually did reasonably well for himself. This is because he stayed the course. He wasn’t adding any more money, but he wasn’t taking money out either. If you are able to stay invested through everything, you’ll probably do pretty well for yourself.

Build the Portfolio that’s Right For You

This is not to say you should simply throw your money at the stock market and stick your head in the sand. You need to consider how much risk you’re actually comfortable taking, and build your portfolio around that. Make sure you can accomplish your financial goals, but your investments shouldn’t be keeping you up at night. It’s important to remember that you shouldn’t be shooting for the high score with your investments – they are a means to an end. To get that high score means taking on a level of risk that is most likely way too high.

In middle school, when I learned about the stock market (in Math class of all places) we played a game where everyone “bought” a stock portfolio. At the end of the month, whoever had the most money won the game. Invariably, the person who won just picked a stock that happened to do really well that month. That’s not a retirement strategy – it’s luck.

Calibrate the level of long term return you’re looking for with the amount of risk that you are comfortable taking. The more risk you are comfortable taking, the higher returns you can shoot for. The less risk you are comfortable taking, the lower (but more steady) returns you should expect. Remember, despite the noise, the market moves in the long term. If you are a long-term investor and not a speculator, your focus is capturing the market returns for the next 30 years, not what the market does on any given day.

Contact McLean today to build the portfolio that’s right for you

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