Bear markets are a preoccupation for many investors and they are one of the primary reasons that the idea of timing the market is attractive. But the reality is that bear markets are the exception and not the norm. The market has risen on average 2 out of every 3 years and bear markets have occurred every 3.5 years. As investors, we think it is helpful to focus on the bigger picture – not just bear markets – and establish realistic investment expectations for portfolio performance. After 15 years of investment management, here is what we have come to expect:
You won’t beat the market consistently, and you shouldn’t plan on doing so. The data is fairly unequivocal that few investors beat the market consistently. Building a financial plan that assumes you will is courting failure. Instead, what we recommend is building a plan based on achieving historical market returns, less any expenses for investing. If you are one of the few investors who manages to beat the market over the long term, you’ll achieve your financial goals that much more quickly. That’s a far better situation in which to find yourself than failing to meet unrealistic return goals and being forced to delay retirement.
Returns are going to be lumpy. Even if we exclude bear markets and the strong growth that typically immediately follows, returns in the markets vary a good deal. A few successive years of tepid returns aren’t unusual, but ultimately something will break the calm and it often happens just when investors begin to assume calm is the norm.
At any given point, at least one of your investments will be disappointing. Different asset classes – like large cap U.S. stocks, or high yield bonds – don’t move in concert, and at any given moment, one asset class has very likely underperformed others for an extended period of time. A good example of this is the underperformance of developed international stocks versus large cap U.S. stocks from 2008 to 2016. Over that time, U.S. stocks returned 7.1% per year while international stocks showed no gain. However, in the 6 years prior to that period from 2002 to 2007, international stocks outperformed U.S. stocks by 14.3% to 6%.
These regime changes of leading and lagging asset classes occur because asset classes revert to their mean return over time. Unfortunately, there is no reliable indicator to signal when these changes will occur, and if you switch at the wrong time, you run the risk of moving from an underperforming asset class just before it begins to outperform. If you are patient though and remain invested according to your plan, capturing both underperformance and outperformance allows you to achieve your plan return targets.