If you’re new to investing, your outlook on the stock market may be influenced by its recent performance. That’s often a natural consequence of suddenly paying closer attention to the market, and thinking that its performance while you’ve been aware of it is similar to what it always has been, or will be. But that’s often not the case.
Consider what happened at the end of the 1990s. The S&P 500® index, a broad measure of the U.S. stock market, had annual returns above 20% five years in a row.* Many people who started investing around that time were shocked when that performance was followed up by negative returns during the following three years.
Similarly, stock market returns of recent years may give new investors pause. There have been wild fluctuations – the S&P 500 had an annual return of -37.0% in 2008, followed in 2009 by a return of 26.5%.* Those gyrations may make you reluctant to invest in stocks.
Your alternative may be a more conservative product, such as a fixed annuity. A fixed annuity that guarantees the rate for 10 years may offer you returns in the 2% to 3% range.*** But consider this: Over the past 10 years, the inflation rate has averaged 2.3%.** That means that your money’s growth in a fixed annuity may be mostly – or completely – eaten up by inflation.
The ups and downs in the stock market – called volatility – are unpredictable and can make you feel woozy if you pay too much attention to them. Fortunately, a method employed by sailors throughout the ages to combat seasickness from the rolling seas works just as well when applied to the gyrations of the stock market: Keep your eyes on the horizon.
If you’re investing for the long term, which is typically the case when you invest in a 403(b) or 457 plan, then day-to-day, even year-to-year volatility isn’t a major concern. What matters is the result at the end of your investment period. To understand how a long investing horizon helps to manage risk in your portfolio, consider the following results – keeping in mind that past performance is not a guarantee of future results.
Ride Out the Downturns
Historically, long-term gains in the stock market have offset short-term losses for long-term investors. As your investing timeline expands, your risk of loss decreases. For instance, from 1926 to 2010, the S&P 500 index had a loss in 24 of those 85 years, or 28% of the one-year holding periods.* If you increase the holding period to five years, just 11 of them (14%) saw a loss. Increase the holding period even further to 10 years, and only four of them, or 5%, had a loss. None of the 20-year periods resulted in a loss.** (See charts.)
These results are just for stocks. A well-balanced portfolio divided among asset classes such as stocks, bonds and cash equivalents may also help you reduce volatility. Different asset classes tend to react differently to identical conditions, so gains in one asset class may help offset losses in another. For more information about how to determine an asset allocation that’s appropriate for your goals, timeline and risk tolerance, read Understanding Asset Allocation. You should also pay attention to rebalancing your assets on a regular basis (read Position Yourself for Success: Rebalance), which can help you manage risk.
In addition, when you invest through your 403(b) or 457 plan, you are automatically practicing dollar-cost averaging, or systematic investing.† This means you continue to buy shares regardless of what the market is doing, so when the market is down, you buy more shares at a lower price.
If you have a long-term outlook, you may want to choose to accept some risk of loss in exchange for greater potential for growth.
* The Standard & Poor's 500® is an unmanaged group of securities and considered to be representative of the stock market in general. While an investment cannot be made directly in an index, a variety of low-cost index funds may be available in your plan’s investment lineup that track an index.
** Source: “Ibbotson® Stocks, Bonds, Bills, and Inflation® (SBBI®) 2011 Classic Yearbook” from Morningstar®. Past performance is no guarantee of future results.
*** Source: www.annuityfyi.com..
† Dollar-cost averaging cannot guarantee a profit or protect against loss in a declining market.
* Source:“Ibbotson® Stocks, Bonds, Bills, and Inflation® (SBBI®) 2011 Classic Yearbook” from Morningstar®. Past performance is no guarantee of future results. The Standard & Poor's 500® is an unmanaged group of securities and considered to be representative of the stock market in general. An investment cannot be made directly in an index.