In times like these, I like to remind myself that scary drops in the stock market are normal. Turmoil in the stock market is normal. Mental pain from being a stock market investor is normal.
For some odd reason, we human beings expect the stock market to be nice. It’s not. It’s mean. And thank goodness for that. If the stock market was nice, like CDs or a money market account, it would earn what CDs and money markets earn. Try amassing enough money to retire on what you earn in your money market account.
In my opinion, the key to being a successful investor is having the right expectations. Without understanding what is normal, you will make decisions based on incorrect assumptions about the market, usually leading to huge mistakes.
So, what is normal for the stock market?
Well, big drops in the market are normal. Look at this table compiled by Ben Carlson at the blog “A Wealth of Common Sense.”
|S&P 500 Daily Moves||% of Trading Days|
|-2% or more||2.1%|
|-1% to 2%||7.7%|
|0% to -1%||36.4%|
|0% to 1%||43.5%|
|1% to 2%||8.2%|
|2% or better||2.1%|
Data from Jan. 1, 1950 to Feb. 5, 2018. Compiled by Ben Carlson.
As you can see, the stock market spends about 10% of its days getting clobbered. (Heck, the stock market loses money on almost half of all trading days.) Daily losses of 2% or more happen around five times a year on average. In addition, in an average year, you can expect around 20 days where you lose between 1% and 2%. Combined, you can expect around 25 trading days a year where you lose 1% or more of your stock investment.
What’s more, stock market losses (and gains) tend to cluster so you can expect to get hit by those big losses over the course of a couple of weeks, not nicely spread out over the year.
For example, Ben notes, in August of 2011, the last time the S&P had a down day of 4 percent or more, the index fell by more than 4 percent on three separate days in the span of a few weeks. There was even a period of four consecutive trading days with a combination of gains and losses exceeding 4 percent.
Even over longer periods of time, the market has some wild swings. According to research by FactSet, a financial research company, from 1978 to 2017, the S&P 500 had market corrections of 10% or more in 22 out of 40 years or 55% of the time.
That’s right, folks, you can expect a 10% or more drop in the stock market every other year. In other words, 10% or more declines in the stock market are normal.
Whether you’re looking at the stock market on a daily basis or over the course of an entire year, volatility is the name of the game.
Now, let’s look at the real scary times: Bear markets. (We’ll define a bear market as a market decline of 20% or more.) According to Yardeni Research, since 1928, there have been 20 bear markets with an average loss of 37.3%.
That’s a bear market every 4.5 years!
(In case you’re wondering, our last bear market ended nearly 10 years ago, so we’re well past due for another.)
Now, let’s recap what is normal stock market behavior so we can set our expectations correctly:
- Daily declines of more than 1%
- 10% declines every year or two
- Nearly 40% declines every five years or so
Of course, normal doesn’t mean enjoyable. Going to the dentist is normal but also uncomfortable.