On the Road Up Expect Lots of Valleys

Even good years can test the will of stock investors

Remember the good old days when the stock market only went up? During the final two decades of the 20th century it seemed like the question wasn’t whether the market would rise year-to-year, but how high would it go. Falling stock prices just weren’t much of an issue in those days.

If that’s how you remember it, you’re not alone. But is that how it really was?

Truth in numbers

The chart below tracks two data elements. In green is the calendar year price change for the S&P 500 index from 1980-2011. In 24 of the 32 years, the index rose in value. During the happy days of 80’s and 90’s it climbed 20 percent or more in nine years and fell only three times. No wonder we remember those years as a one way street going up.

S&P 500 returns 1980-2011 and intra-year declines
Data source: Yahoo Finance.
Click here for larger image

But there’s more to the story. The red dots show the largest intra-year decline for each year. For the three-decade period, the average intra-year decline has been more than 14 percent. These declines, even in up years, have often been steep enough to shake investor confidence.

For instance, in 1980 the index gained 26 percent. But at some point during the year the index fell by 17 percent. To make the big annual gain, investors needed to sit tight during a dramatic and troubling slide.

Jaggedly we go

Consider 1998, charted below, as another example. The index rose a handsome 27 percent for the year, but took a very jagged path to get there. After a nice climb of approximately 20 percent by mid-July, prices slammed into reverse and all of the gain was gone by late August. The index climbed again in September, fell again in October, and then finished the year with a big rally.

S&P 500 price change 1998
Data source: Yahoo Finance.

As a whole 1998 was a great year for S&P investors, but the late summer decline of 19 percent, easily forgotten by year-end, surely felt like a dangerous freefall at the time.

Package deal

It’s natural to remember the big market trends (up in the 80’s, up in the 90’s, and down/sideways in the 00’s) and forget the short-term moves along the way, especially those that go against the trends. But even when the trend is up, the declines do matter; they’re part of the package one buys with every stock or mutual fund share. The risk of significant and discouraging short-term losses is simply the price of admission for the opportunity to reap potential long-term gains.

The S&P 500 index started 1980 at 108. In early 2012 it is now over 1300 (before adding the significant benefit of reinvested dividends). Investors who have been able to stomach all the rollercoaster dives along the way – sometimes feeling like they were holding on for dear life – have earned a nice return.

The future moves of this or any other investment can’t be predicted, but there’s no reason to expect the future to be any less volatile. With the ups there will be downs.

© 2012 Bright Sky Group, LLC. All rights reserved.

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