Another Way to Look at Volatility

The Stock Market is Volatile.

It's volatile on a daily basis. It's volatile on a monthly basis. And it's volatile on a yearly basis.

Take a look at the first two charts below which show the 20-year period of monthly and yearly returns respectively for:

1. The S&P 500 index (the stock market),
2. The bond market, and
3. The even more volatile large company growth index. 

As the 10 time World Series champion New York Yankees catcher Yogi Berra famously said, "You can observe a lot just by watching."

So let's do that, the "average" monthly return for the stock market (orange line and number) is 0.68%, yet it's not uncommon for the stock market to experience negative monthly returns of -10% and even -15%. Most recently we experienced a -8% drop in February of 2020 followed by a -12% drop in March of 2020, to then rebound with +18% return in April and an almost +8% return in May. 

Notice the lines of both the orange (stock market) and purple (large company growth index) vacillate quite frequently between positive and negative monthly returns, meaning it's been very common for there to be many negative months. Conversely, if you look closely at the blue line (bond market), you'll notice the volatility is substantially lower than the orange and the purple line. As the graph and number show the bond index has averaged a monthly return of 0.35% over the last 20 years and has been substantially less volatile than the stock market. 

When we look at the yearly returns of these same 3 indexes you'll notice the less frequent negative returns for both the stock market and the large cap growth indexes. In fact, the last 20 years has been pretty average in terms of the number of yearly negative returns. We've had 5 years with negative returns in the stock market (2000, 2001, 2002, 2008, and 2018), so said another way, we've had 15 years of positive returns. Notice the average yearly returns for the 3 indexes, the large company growth average 9.46%, the stock market averaged 7.51%, and the bond market averaged 4.25%. Keep these return percentages in mind when you look at the third and last chart. 

As mentioned above, 25% of the time the stock market has experienced negative calendar returns. Yet, despite the stock market posting negative returns once every 4 years (on average), investors who were able to stomach the volatility, were rewarded handsomely. An initial $10,000 grew to over $50,000 in the stock market, while the bond market index grew to just over $20,000. What's utterly amazing is the growth of the large company growth index (QQQ), which turned every $10,000 into over $100,000. A 10x return on every dollar invested - this is truly remarkable. 

It's important to understand your goals and know your ability to withstand market volatility, because, "If you don't know where you are going, you'll end up someplace else," as Yogi Berra also said. Without a rock solid plan and your ability to stick to it, you might end up in a place that you didn't imagine. 

​-Paul R. Rossi, CFA

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