This disturbing S&P 500 stat actually makes the case for index investing
Diversification can help keep your blood pressure under control
Bloomberg’s Jonathan Ferro1 has been sharing this interesting quote from Morgan Stanley addressing the year-to-date performance of the S&P 500.
…88% of S&P 500 members have experienced at least a 10% drawdown. Meanwhile, on a closing price basis, the index has only corrected by 5%. That is a historical anomaly.
That comes from Michael Wilson, the investment bank’s chief U.S. equity strategist and one of Wall Street’s most closely-followed stock market forecasters.
The quote is jarring. It’s disturbing to hear that almost all of the individual stocks in the S&P 500 have seen double-digit selloffs from their highs this year. And it’s unsettling that it’s a historical anomaly for those selloffs to occur despite a more modest decline at the index level.
But if you’re among the investors with an estimated $5.4 trillion parked in funds passively tracking the S&P 500, you might consider Wilson’s observation a perfect example of why people invest in broadly diversified index funds.2
By being diversified across the S&P 500 – instead of just a handful of S&P 500 constituents that may have gotten you overexposed to this year’s big losers – your portfolio was made a lot less volatile.
It helps keep your blood pressure down as you check in on your retirement accounts, because it’s certainly easier to stomach a 5% decline in you portfolio than a 10% drop.3
That said, you should be ready for a 10% drop…
Wilson ran the historical numbers and found “all other years where at least 85% of S&P members corrected by 10% or more were also met with an index level correction of at least 10%.“
This doesn’t guarantee imminent trouble for the stock market. But investors should nevertheless always be prepared for these larger selloffs.
We are currently in year two of a bull market, and year two sees the S&P 500 experience an average selloff of 10%.
That said, year two also ends with an average gain of 12.6%.
Broadly speaking, most years experience big selloffs, but most years also end with the market much higher.
Summing it up
Investing in the stock market means seeing lots of scary stats and experiencing lots of scary selloffs. While these signals can sometimes precede worse things to come, it’s often just a normal phenomenon in an upward trending market.
Read more about all this in 10 Truths About the Stock Market.
Follow Jonathan Ferro on Twitter. He’s great at summing up the day’s market-moving news in 280 characters or less. All before the U.S. markets open.
This type of passive investing has become increasingly popular in recent years, with prominent figures like Warren Buffett directing followers to them.
While diversification can limit the downside, it can also limit the upside. Stocks that fall a lot are often the ones that see the biggest gains. Unfortunately, identifying those big winners isn’t exactly easy.