Data that can help you keep a cool investing head in a crisis

Markets have continued to fall as investors focus on the longer-term outcomes of the Russia and Ukraine conflict.

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We first published this research in the days following Russia’s invasion of Ukraine earlier this year. Since then, markets have continued to fall as investors focus on the longer-term outcomes of the conflict and how these play into other concerns including sharply higher inflation, rising interest rates and a potential recession. In this updated version of the original article, we suggest our core arguments continue to hold true.

1. Stock market investing is very risky in the short run but less so in the long run – unlike cash

Using almost 100 years of data on the US stock market, we found that, if you invested for a month, you would have lost money 40% of the time in inflation-adjusted terms ie in 460 of the 1 153 months in our analysis.

Past performance is not a guide to the future and may not be repeated. US Large-Cap Stocks, stocks and cash represented by Ibbotson® SBBI® US (30-day) treasury bills. Data January 1926 to January 2022.Source: Morningstar Direct

However, if you had invested for longer, the odds would shift dramatically in your favour. On a 12-month basis, you would have lost money slightly less than 30% of the time. More importantly, 12 months is still the short run when it comes to the stock market. You’ve got to be in it for longer.

On a five-year horizon, that figure falls to 23%. At 10 years it is 14%. And there have been no 20-year periods in our analysis when stocks lost money in inflation-adjusted terms. Losing money over the long run can never be ruled out entirely and would clearly be very painful if it happened to you. However, it is also a very rare occurrence.

In contrast, while cash may seem safer, the chances of its value being eroded by inflation are much higher. And, as all cash savers know, recent experience has been even more painful. The last time cash beat inflation in any five-year period was February 2006 to February 2011, a distant memory. Nor is that something that’s expected to change any time soon.

2. Falls of 10%+ happen in more years than they don’t – but long-term returns have been strong

By late May, US equities had fallen by approximately 19% in 2022. In the US, 10% falls happened in 28 of the 50 years prior to 2022. In the past decade, this includes 2012, 2015, 2016, 2018 and 2020. More substantial falls of 20% occurred in eight of the 50 years (that’s roughly once every six years – but if it happens this year, that will be twice in the past three, in 2020 and 2022). Despite these regular bumps along the way, the US market has returned 11% a year over this 50-year period overall. The risk of near-term loss is the price of the entry ticket for the long-term gains that stock market investing can deliver.

Past performance is not a guide to the future and may not be repeated
Past performance is not a guide to the future and may not be repeated. Data to 18th May for MSCI USA index. Chart shows 2022 data to 18 May. 605092. Source: Refinitiv and Schroders.

3. Bailing out after big falls could cost you your retirement

While the market hasn’t fallen too much so far, further volatility and risk of declines cannot be ruled out. If that happens, it can become much harder to avoid being influenced by our emotions – and be tempted to ditch stocks and dash for cash.

Past performance is not a guide to the future and may not be repeated. Monthly cash return 1934-2020 based on a three-month treasury bill, secondary market rate: 1920-1934 based on yields on short-term US securities; 1871-1920 based on one-year interest rate. This data only available annually so a constant return on cash has been assumed for all months during this period. Other data is monthly. All analysis is based on nominal amounts. Source: Federal Reserve Bank of St Louis. Robert Shiller. Schroders.

However, our research shows that, historically, that would have been the worst financial decision an investor could have made. It pretty much guarantees that it would take a very long time to recoup losses.

For example, investors who shifted to cash in 1929, after the first 25% fall of the Great Depression, would have had to wait until 1963 to get back to breakeven. This compares with breakeven in early 1945 if they had remained invested in the stock market. And remember, the stock market ultimately fell over 80% during this crash. So, shifting to cash might have avoided the worst of those losses during the crash, but still came out as by far the worst long-term strategy. Similarly, an investor who shifted to cash in 2001, after the first 25% of losses in the dotcom crash, would find their portfolio still underwater today.

The message is overwhelmingly clear: a rejection of the stock market in favour of cash in response to a big market fall would have been very bad for wealth over the long run.

4. Periods of heightened fear have been better for stock market investing than might have been expected

A combination of the war between Russia and Ukraine, soaring inflation and tightening monetary policy have sent the stock market’s “fear gauge”, the VIX index, higher. The VIX is a measure of the amount of volatility traders expect for the US’ S&P 500 index during the next 30 days. It reached a level of 31 on 19 May, well above its average since 1990 of 20, and steeply higher than its start-of-year level of 17.

Past performance is not a guide to the future performance. Note: Levels in excess of 33.5 represent the top 5% of experience for the Vix. Portfolio is rebalanced on a daily basis despending on the level of the Vix at the previous close. Data to 18th May 2022. Figures do not take account of any costs, including transaction cost. Source Schroders, Refinitiv. 605092
Past performance is not a guide to the future performance. Note: Levels in excess of 33.5 represent the top 5% of experience for the Vix. Portfolio is rebalanced on a daily basis despending on the level of the Vix at the previous close. Data to 18th May 2022. Figures do not take account of any costs, including transaction cost. Source Schroders, Refinitiv. 605092

However, historically, it would have been a bad idea for investors to sell out during periods of heightened fear.

Duncan Lamont, CFA Head of Strategic Research, Schroders

We looked at a switching strategy, which sold out of stocks (S&P 500) and went into cash daily whenever the VIX was above 30, then shifted back into stocks whenever it dipped back below.

This approach would have underperformed a strategy which remained continually invested in stocks by 2.9% a year since 1991 (6.7% a year vs 9.6% a year, ignoring any costs). A $100 investment in the continually invested portfolio in January 1990 would have grown to be worth nearly 2.5 times as much as $100 invested in the switching portfolio.

As with all investment, the past is not necessarily a guide to the future, but history suggests that periods of heightened fear, as we are experiencing at present, have been better for stock market investing than might have been expected.