Should I Be Worried About The Recent Drawdown?
The true investor welcomes volatility… a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.
— Warren Buffett
After a period of 1.5 years of relative calm and a rise in asset prices, volatility has once again descended on markets. The news is trying to pin it on various factors — war fears, a hawkish Fed, a tech bubble, and even on Netflix.
This has resulted in renewed anxiety for many investors. While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Despite whatever “investment experts” try to pin the blame on, the market continues to function as intended, complete with its usual fluctuations.
Let’s take a look at global stocks represented by the MSCI World Index rebased to SGD. In the chart below, the bars represent the annual returns of global stocks while the dots represent the largest corrections or drawdowns during that year. You may be surprised that large drawdowns can occur even during years where annual returns end up being positive.
Let’s break it down. This data series stretches for 41 years; of the 41, markets were positive for 31 years, with negative returns for 10. This means you are likely to end up with positive returns as markets are green at least 76% of the time. However, you will definitely see a sell-off or correction for every single year. Out of these 31 positive years, there were 20 where the sell-off during the year was more than -10%.
This just goes to show just how common market declines are and how difficult it is to predict whether a large decline during the year will result in negative returns by the end of the year. Although we cannot predict the future, looking at the past may provide us with some assurance. For those who prefer to look at numbers, the table below quantifies the data of the largest decline during the year vs. the overall annual return.
The recent COVID-19 pandemic crash maybe be an extreme example but it’s not uncommon. In 2020, stocks experienced a -31% drawdown but still ended up positive with an overall return of 12%. This has happened numerous times in the past, with 2009, 1998, 1987 being notable examples.
No doubt, the volatility coupled with the news flow and the live look at crashing market prices can seem scary. This is why for all our portfolios, there is a defined risk number in terms of Value-at-Risk. This provides perspective as to how much loss you can reasonably expect from your investments. There are also worst and best case scenarios as well to give you an idea what to expect, when you least expect it.
We don’t know whether the future could be worse than what we have seen before but we are certain that as long as you hold a well diversified portfolio with defined risk attributes, you can reach your goals with relative ease. Just stick to the path that your advisor has charted for you and try not to overreact when markets are jumpy. As Warren Buffett said, you should welcome volatility — the best and most successful investors have the guile to put money to work when markets take a dive.
