The Combo Deal: Navigating Growth and Declines
As we reflect on another strong year in the equity markets, we remain steadfast in our pursuit of helping clients achieve their lifetime goals. The journey towards these goals requires not just a commitment to sound investment principles, but a deep understanding of the inherent risks and rewards in the markets.
Our investment philosophy is simple and enduring:
We are long-term, goal-focused investors who build broadly diversified portfolios of high-quality businesses.
We recognize that the economy is unpredictable, and market timing is impossible. Therefore, the only way to capture the premium long-term returns of equities is to remain invested through the inevitable, but historically temporary, declines.
We do not react to short-term market movements or economic events. As long as your long-term goals and life circumstances remain unchanged, so too will our strategy to achieve those objectives.
As we begin a new year, it's a natural time to revisit long-term financial plans. One of the common questions we receive during this process is: What investment returns should we assume for the future? To answer this, we often frame it this way:
9%, -14%, -33%
These numbers encapsulate the expected long-term growth of equities and the inevitable volatility along the way. Let’s break them down:
9% Growth – This is the average annual return we expect from equities over time. It’s the premium that equities offer over cash and bonds. But why do equities deliver this higher return? Simply put, it’s the compensation you earn for enduring the risk of significant declines that can occur along the way.
-14% Intra-Year Decline – On average, during any given year, equities experience a peak-to-trough decline of about 14%. This figure is important because it underscores the volatility investors must endure in order to realize the long-term growth equity markets can offer. Interestingly, despite these annual dips, 75% of calendar years have positive returns.
-33% Bear Market Decline – On average, equities experience a bear market—defined as a decline of 20% or more—roughly once every five years. The depth of these bear markets tends to be significant, with an average decline of 33%. In the 21st century alone, we’ve seen two bear markets with losses near 50%.
This, in essence, is the "combo deal" we face as investors: the expectation of 9% growth, alongside the inevitability of 14% intra-year corrections and 33% bear market declines. They are inseparable. You cannot expect the returns without also accepting the volatility that comes with them.
However, when these declines occur—and they will—it's crucial to remember they are not derailments. In fact, they are built into our financial plans. Without these declines, the 9% historical average return would not be possible. They are an essential feature of the market's structure, driving the premium that equities provide over time.
It's important to note that the 14% decline will not happen precisely every year, nor will bear markets always fall exactly 33% twice every decade. These are averages, not certainties. But the fact remains that significant declines are a part of the market’s natural cycle.
Through it all, the resilience of companies and economies has been a powerful force for recovery. Over the long term, these declines have always been temporary, and equities have historically continued their upward trajectory.
As we plan for the future, we must plan for both the growth and the declines. The combo deal is not a burden, but a necessary and expected element of long-term investment success.
SOURCES:
JPMorgan Asset management: Guide to the Markets
Dimensional Fund Advisors “Do Downturns Lead to Down Years?”
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Investments involve risk and, unless otherwise stated, are not guaranteed. The Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is not indicative of future results. Readers of this information should consult their own financial advisor, lawyer, accountant, or other advisor before making any financial decision.
In USD. Data is calculated off rounded daily returns. US market is represented by the Russell 3000 Index. Largest intrayear decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
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