This year has been a brutal one for investors. Stocks are down, bonds are down, real estate is down—there has been nowhere to hide.
The Toronto Stock Exchange net total return is negative 11% year-to-date. The S&P 500 has been much worse, with a 23% drop. Canadian bonds, as measured by the FTSE Canada Universe Bond Index, have lost 13%.
This is understandably concerning this is for investors who are asking themselves, “When will the losses stop?”
This type of thinking is known as “recency bias.” It is a tendency to believe that recent events, like investment losses, are likely to persist in the future. The same bias can cause an investor to take on too much risk when things are going well. Interestingly, the more stocks go down, the more likely they are to go back up.
Long-term investing during bear markets
Since 1950, the S&P 500 has gone down 25% or more on nine occasions—including this year. That 72-year time horizon is probably a good reference for an investor’s lifetime. In other words, an investor who starts investing when they are 18 and lives to 90 might expect to live through nine periods when their stocks go down by more than one-quarter based on market history. That is once every eight years.
During these previous eight historic bear market events, the average decline was 39%. The average 1-year return from the market bottom was 22%. One of those eight periods occurred during February and March 2020, when the pandemic began, so we have not yet seen the subsequent 5- and 10-year returns from the market trough. But for the other seven, the 5- and 10-year returns averaged 13% and 12% annualized, respectively.
Stocks vs GICs
So, should you move your money into guaranteed investment certificates (GICs). GIC rates are great right now, paying 4.5% to 5%. Those rates could move higher still. After losing money in stocks, if Investors were to sell and buy a 5-year GIC paying 5%, their annualized return over the next five years would be 5%. Based on historic stock market downturns, the subsequent 5-year stock market returns have been more than double that.
Should history repeat itself, one can guess—because that is all it is, a guess—that stocks will provide a better return over the next five years than a GIC. And if you have a globally diversified portfolio, it is more likely your returns will be strong compared to owning a portfolio of a few stocks in a few sectors with more company or sector risk.
When it makes sense to hold onto stocks
Day to day, whether stocks will be up or down is basically a coin toss. Year to year, they have been up historically more than two-thirds of the time. Investors with a long-time horizon should invest based on their risk tolerance to avoid panicking and selling at a low point, ideally holding as much exposure to risk assets as they can handle.
Should you invest in mortgage funds?
How about investing in a mortgage fund? There are publicly traded as well as private mortgage funds that are eligible to purchase in registered accounts. There is no magic to a mortgage fund. The expected returns are generally higher than GICs but so too is the risk. The upside potential is also limited if you are thinking of selling your stocks at a loss today to buy a mortgage fund. Arguably, stock market returns may be higher over the medium term. If you decide to buy a mortgage fund, it should be a small percentage of your account with a well diversified exposure to other types of investments that fit with your risk tolerance.