Client Question of the Month

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November 2018 Client Question: Market Volatility

Client Question of the Month |

Andrew Murphy, CFA
Director of Portfolio Management

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Along with our monthly recap we will also address a client question that has been top-of-mind recently. We get our ideas for these topics through our client conversations and interactions. If you have an idea for a question or subject, please reach out to us.

In our October piece on bear markets and recessions we discussed that the stock market has historically gone up over time, but the returns are rarely in a straight line as market volatility is a common occurrence. This month, we will take an in-depth look at these topics.

In 2018, the stock market has experienced two corrections (a decline of greater than -10%) and an overall increase in volatility compared to last year. 2017 was an abnormal year as the market returned +21.8% while the largest intra-year decline was only -3%. One of our main themes of 2018, was that we expected volatility to increase from historically low levels. We want to highlight that the volatility in 2018 is closer to historical averages than it was in 2017.

At Winthrop Wealth Management maintaining a long-term viewpoint is one of the core tenets of our investment philosophy. We believe that most successful investment strategies employ a long-term approach as markets can be extremely volatile in the short-term. The following data from Bloomberg and JP Morgan makes a compelling case for long-term investing.

The stock market has historically gone up over time:
Since 1980, the S&P 500 has generated a total annualized return of +11.6%. To put this return in perspective, $100 invested in 1980 would be worth over $7,000 today.1 The stock market has done incredibly well over the last 39 years, but it is important to remember that the returns were not linear. Annual returns ranged from -37.0% to +35.5%. In fact, there was only one year where the S&P returned between 11% and 12% (2016). Also keep in mind that this time period includes some of the most volatile periods in history, including the 1987 Crash, Tech Bubble, and Global Financial Crisis.

Returns are rarely in a straight line as market volatility is a common occurrence:
Despite overall positive returns since 1980, there were plenty of declines along the way as the average intra-year price decline was -13.8%. This simply means that at some point each year the S&P 500 dropped by an average of -13.8%. The data makes sense as since 1950 the stock market has averaged at least one correction each year. This reinforces our long-term investment philosophy – since we plan for stock market volatility and we incorporate these assumptions into our financial plans, we are less likely to overreact when it happens. The following chart displays the S&P 500’s annual return vs. the largest intra-year decline since 1980.

Conclusion
Equity markets have historically provided excess returns over the risk-free interest rate (3-month US Treasury Bill) over long time periods. The risk-free interest rate is defined as the return of an investment with no risk of financial loss. Since 1960, the excess return of the S&P 500 over the risk-free interest rate has averaged about 6% each year. As investors, volatility is the price we pay for that excess return. We understand that volatility can be stressful. However, the right mindset combined with a detailed financial plan and a thorough investment process can make volatility much more palatable. As always, we encourage our clients to maintain a long-term viewpoint while remaining focused on their overall goals and objectives.

At Winthrop Wealth Management, financial planning works in concert with investment management. The Financial Plan, which helps clients define cash flow needs and future objectives, drives the investment management strategy. The investment management process is designed to provide well-diversified portfolios constructed with a methodology based on prudent risk management, asset allocation, and security selection.

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Andrew Murphy, CFA
Director of Portfolio Management

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Disclosures:

Securities offered through LPL Financial. Member FINRA/SIPC. Investment Advice offered through Winthrop Wealth Management, a Registered Investment Advisor and separate entity from LPL Financial.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The S&P 500 is an unmanaged index which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

[1.] This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk, including the risk of loss. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.