Investors who stick to a long-term strategy can even out the best and worst excesses of the market.
Despite a recent jump triggered by tensions over North Korea, stock markets around the world are on track to record their least volatile year since before the global financial crisis.1 But investors would be wrong to believe that volatility is a thing of the past, as markets grapple with a long list of geopolitical and economic uncertainties.
Short-term volatility remains an inherent feature of equity markets and there is always the potential for the value of an investment to rise or fall sharply.
The chart below illustrates the best and worst annualised returns for the FTSE All-Share Index over different holding periods since 1985.
As the chart shows, the variance and volatility in returns over one year can be extreme. In the 12 months ending in October 2008, investors in the UK market suffered a fall of over 34%. In contrast, the one-year return up to September 1987 was over 62%; a stunning but probably unrepeatable result.
Source: Financial Express; data for the FTSE All-Share Total Return Index from 31 December 1985 to 31 July 2017
Studies suggest that investors feel the pain of losses twice as much as they enjoy the gains.2 But losses are only realised if investors, unable to hold their nerve, react to short-term volatility by cashing in their investment.
Given the choice, most investors would opt for a steadier return profile that doesn’t provide too many surprises. The chart above shows that investors who commit to a long-term strategy can even out the peaks and troughs to generate returns that are far more consistent over time.
For example, over 140 different 20-year periods, the lowest annualised return for investors in the FTSE All-Share Index would have been 6.27%. The best annualised return would have been 11.54%.3
In contrast to the volatility in the best and worst returns over much shorter time periods, the rewards for patient investors are fewer surprises and an increased likelihood of achieving their financial goals.
1 VIX index: https://finance.yahoo.com/chart/%5EVIX/
2 Kahneman and Tversky, Prospect Theory: An Analysis of Decision under Risk, 1979
3 See chart
Past performance is not indicative of future performance, and the value of your investment, as well as any income, may go down as well as up. You may get back less than you invested.
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