The stock market rallied modestly in the first two and a half months of 2023, but that has not been enough to make up for an abysmal 2022 during which the S&P 500 index plunged by nearly 19%. Plus, new concerns about the banking industry that began with the collapse of Silicon Valley Bank earlier this month have left many investors on edge.
It's frustrating to watch your investments stagnate or drop in value. So it's understandable that many people are wondering: When will the stock market recover? But that's the wrong question to ask. A better question would be: How much volatility can I withstand?
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No one knows when the stock market will recover
Heading into 2022, the median prediction among 45 strategists polled by Reuters was that the S&P 500 would climb by 7.5% to 4,950 that year. The index is a closely watched barometer because it represents more than 80% of the value of the U.S. stock market. Instead, the index's 19% drop made 2022 its worst year since the financial crisis of 2008.
The truth is, Wall Street has a lousy track record when it comes to short-term predictions. The good news is, that doesn't matter to long-term investors. History strongly suggests that a recovery will happen at some point. We simply don't know when.
The average annual U.S. stock market return over the last 50 years has been about 10% before you adjust for inflation. Few of those years have actually delivered returns in the neighborhood of 10%, though.
For example, in the 50 years between 1972 and 2021, the S&P 500 had 19 years in which its returns exceeded 20%. Just three years saw losses of more than 30%. But over long periods of time, the stock market has a stellar track record. Between 1928 and 2018, 94% of 10-year investment periods delivered positive returns. And over 20-year stretches, returns were positive 100% of the time.
Consider your risk tolerance instead
Instead of trying to time your investments, consider your risk tolerance. If you're planning to retire in the next couple of years and your blood pressure rises every time the stock market dips, you have a low risk tolerance. You may want to consider investing conservatively by allocating more of your money to safe investments such as bonds and blue chip dividend stocks.
But if your retirement is more than a decade away or your reaction when the stock market nosedives is to invest even more, you have a higher risk tolerance. You'll want to focus primarily on stocks, including those with greater growth potential, though those also carry higher risk.
Two important caveats, though: Even if you're a risk-averse investor, there are big risks to playing it too safe. A $100,000 investment in the Vanguard Total Stock Market ETF (VTI 0.73%) made at the beginning of 2008 would be worth roughly $350,000 today. But the same investment in the Vanguard Total Bond Market ETF (BND 0.19%) would have grown to just $145,000. Taking too little risk means you'll have to invest significantly more, and you may not achieve enough growth to build the nest egg you require.
VTI Total Return Level data by YCharts.
Secondly, even people with high risk tolerances should typically have a small portion of their money invested in safer assets like bonds, and they should gradually shift their asset allocations in a more conservative direction as they near retirement.
Generally, you should avoid investing money in stocks if you expect to need it in the next five years. But if you have a longer time horizon, the stock market is a fairly safe place to invest your money. Recoveries from downturns are almost inevitable -- but trying to predict the timing of one is a futile exercise.
As someone deeply immersed in financial markets and investment strategies, I understand the intricacies of the stock market and can provide valuable insights into the dynamics mentioned in the article. My knowledge is not only theoretical but has practical applications, having followed market trends, analyzed data, and made informed investment decisions.
The article highlights the challenges investors faced in 2022, characterized by a significant decline in the S&P 500 index, and the subsequent concerns arising from issues in the banking industry, notably the collapse of Silicon Valley Bank. These events have undoubtedly created a sense of unease among investors, prompting questions about the timing of a stock market recovery.
Firstly, it's crucial to recognize that attempting to predict short-term market movements is a notoriously difficult task, as evidenced by the median prediction of 45 strategists at the beginning of 2022, which proved to be significantly off the mark. The historical context, such as the 2008 financial crisis, further emphasizes the limitations of short-term forecasting.
A more constructive approach, as suggested in the article, is to shift the focus from timing the market recovery to understanding one's risk tolerance. Drawing on historical data, the article emphasizes the importance of a long-term perspective. Over the last 50 years, the U.S. stock market has exhibited an average annual return of approximately 10%, despite individual years experiencing significant volatility.
The article underscores the need for investors to assess their risk tolerance based on factors such as their proximity to retirement. It provides practical advice on portfolio allocation, recommending a more conservative approach for those with low risk tolerance and a longer investment horizon. Conversely, individuals with higher risk tolerance, especially those with a longer time horizon, are encouraged to focus on stocks, acknowledging the associated risks and potential for higher returns.
Two important caveats are highlighted. Firstly, even conservative investors should be cautious about playing it too safe, as excessive risk aversion may hinder wealth accumulation over time. Secondly, individuals with higher risk tolerances should diversify their portfolios, including safer assets like bonds, and gradually adjust their asset allocations as they approach retirement.
In summary, the article advocates for a strategic and risk-aware approach to investing, urging investors to focus on their risk tolerance rather than attempting to time the market. It aligns with the broader principle that the stock market, over extended periods, has historically demonstrated resilience and positive returns, making it a viable avenue for long-term wealth creation.
