By Rolf Agather, managing director, US research
The Russell indexes were designed to provide a complete, accurate, and investable representation of the US equity market. As a result, with over 40 years* of performance and characteristic data, the Russell Indexes serve as a valuable tool for helping investors make wise investment choices.
If you were to look past the market volatility that engulfed markets in the wake of the US-China trade talks, you wouldn't have to look too hard to find other instances of market-driven melodrama in our recent past. “The fourth quarter was a bad time to be in the stock market,” was a common refrain on the financial news channels earlier this year. And indeed, the last three months of 2018 proved to be a trying market for stocks—the Russell 3000® Index dropped 14.3% for the quarter, erasing the market’s 10.6% return up through September 30 and causing the annual return for 2018 to be 5.2%.
As a long-term investor, it struck me that this sort of commentary can potentially encourage poor decision-making, especially for younger investors who are starting to save for retirement or some other financial goal where their assets will not be needed for quite some time. In addition to diversification, a long-term investment horizon is a powerful tool for weathering market volatility, so investors should be very deliberate when setting their investment objectives. Investors who do not need their investment assets for a number for years shouldn't worry about the market's ups and downs over days and weeks, or even months.
While the US stock market can be highly volatile over short time frames, over the long run it has provided incremental return over less risky assets like bonds or cash, and has outpaced inflation so that purchasing power has truly increased. The chart below shows annual returns for the Russell 3000 for the 40-year period ending in 2018. On a calendar year basis, the market was up as much as 36.8% (1995) and down as much as -37.3% (2008), rendering it as an inhospitable place for investors who may need to access their assets within a short time.
Source: FTSE Russell as of December 31, 2018. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
As an investor's time horizon increases, however, the longer term behavior of the US market starts to smooth out. The next chart plots rolling 5-, 10-, and 20-year annualized returns for the Russell 3000 over the last 40 years.
Source: FTSE Russell as of December 31, 2018. Past performance is no guarantee of future results. Returns shown prior to index launch represent hypothetical, historical data. Please see the end for important legal disclosures.
Here we see that the volatility during shorter periods actually causes extreme ups and downs to start canceling each other out. We don’t see extreme market upturns or downturns compounding to create even more extreme events—instead, we see that the combination of both ups and downs experienced during shorter periods causes the highest and lowest returns of the longer horizons to be less extreme. In the case of 20-year investment horizons, we can see that the highest annualized return was 17.8% (ending 3/31/2000) and the lowest annualized return was 6.0% (ending 12/31/2018), which are very different than the extremes of the calendar year periods. Also of note, the number of times an investor would have experienced a loss in capital (a negative return) decreases as the horizon extends; over the last 40 years every 20-year time horizon experienced a positive return, 95% of 10-year horizons and 90% of 5-year horizons were positive.
While past performance is no guarantee of future results, history clearly shows that investors with longer investment horizons have fared better. An individual just starting to contribute to a retirement plan potentially has a 30-40 year horizon, even parents starting a college fund for a young person may have a 10-15 year horizon. For these investors, now is a great time to be in the US stock market.
* Russell produced five years of history prior to the inception of the indexes
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