This question is one we get asked all the time and the short answer is yes. To be clear, this is not me making some outlandish prediction about shares as if you know anything about how we view investing you would know that this is the last thing we recommend you do. The reality is though, the share market does not always go up, so a drop in prices is inevitable.
Now if you are here because you thought that you would read an exact date and time when shares were about to ‘bottom out’ again then I apologize but you might as well stop reading now. That said, if you are interested in improving your knowledge about what often happens after shares drop in value then you are in the right place. Armed with this information, you should be far better prepared to deal with this when it eventually happens. Because it will.
History has shown us that stock markets around the world increase in value between 70% and 80% of the time. Those are pretty good odds. I was shocked to see that the #1 ranked AFL (Australian Football League) player for season 2021 has been able to execute an effective kick going inside the 50-meter arc a whopping 36% of the time. That’s the #1 ranked player in the whole competition so it doesn’t get any better than that!
Now, not only do shares increase in value more often than not, but they also are quite resilient when we see a drop in value. Take the below chart for example which shows how the US stock market has behaved following downturns of 10%, 20%, and 30% respectively. And this is going all the way back to July 1926.
Sudden market downturns can be unsettling, there’s no doubt. But historically, US equity returns following sharp downturns have, on average, been positive. Some of these numbers really drive home the point that it shouldn’t be about trying to time the market and instead, it’s about ‘time in the market’.
Some things that stand out to us:
- A broad index tracking data since 1926 in the US shows that stocks have tended to deliver positive returns over one-year, three-year, and five-year periods following steep declines
- Cumulative returns show this to striking effect. Five years after market declines of 10%, 20%, and 30%, the compounded returns all top 50%.
- Viewed in annualized terms across the longest, five-year period, returns after 10%, 20%, and 30% declines have been close to the historical annualized average over the entire period of 9.7%.
- Specifically, the average annualized returns for the five-year period after 10% declines were 9.54%; after 20% declines, 9.66%; and after 30% declines, 7.18%.
It’s impossible to perfectly predict when your portfolio of shares is about to drop in value. Even if you get lucky and predict this correctly that’s only one half of the equation as you also need to predict when the recovery is about to begin. Our advice is don’t bother playing this game and independent research backs this up (check out the SPIVA Report if you’re interested in the detail).
Thankfully, there’s a simpler way that doesn’t involve as much risk and over the long-term has proven time and time again to work. Rebalance your portfolio regularly and stick to a plan – if you can do these two things you are already ahead of most other investors. If you really want to take your portfolio to the next level then we would strongly consider adopting a philosophy built on Nobel Prize-winning research.
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