Source: Flickr user Nithi Anand.
One of the most important things investors can learn is that perspective is everything. Depending on your time horizon, stock returns have been excellent, or...well, terrible.
How we perceive the stock market's performance depends on when we invested. Take a brief look at the data below, which shows annualized returns for one of the most popular index funds by holding period.
Depending on how long you've been invested, the recent performance of the stock market has a large or small impact on your returns.
Vanguard S&P 500 Index (NASDAQMUTFUND:VFINX) returns by holding period
Annualized total return
To the investor who bought the index 5 years ago and never looked back, the stock market is an incredible wealth creator. To the new investor, the stock market appears to be just another money pit.
Are we in a bear market?
The stock market is officially in a correction, having dropped by more than 10% since December 29, 2015, but it isn't yet in bear market territory. A bear market happens when stocks drop by more than 20%.
Again, though, perception is everything. Depending on what you have invested in, you'll have a very different experience than the average investor.
The chart below shows the performance of various sectors of the S&P 500 Index(SNPINDEX:^GSPC) compared to the high price achieved over the last 52 weeks. Depending on what you own, you've experienced a vastly different return than the average investor.
Consumer staples stocks, which count household names like Procter & Gamble, Coca-Cola, and Philip Morris International as their biggest holdings, have held up quite well. These recession-resistant companies are trading at a modest 6.6% discount to their peak price achieved over the last year, on average.
However, commodity-related industries have taken a bloodbath. Energy and materials are down 39% and 29% from their 52-week highs, respectively. If you go back to when energy stocks broadly peaked in 2014, the losses in this industry are closer to 50%.
Similarly, financial services stocks, whose earnings ebb and flow with the health of the financial markets, are on the cusp of bear market territory, having declined 19.5% from their 52-week highs.
Despite the outliers, the diversified investor has experienced modest losses of about 14% from the 52-week peak. That's a tolerable decline, even if it does feel a little painful. The lesson, of course, is that diversification can smooth out the ups and downs of any one industry.
A different kind of diversification
Hopefully you invest a consistent amount each pay period into a 401K or IRA, and hold a diversified portfolio of stocks and bonds.
If so, you've diversified two-fold by holding different types of investments, and by purchasing them at different prices and times. Investors who make regular retirement contributions buy at any price, sometimes low, and sometimes high. Only with hindsight can we really say if prices are high or low.
But what we can know is that history tells us that the most wealth is created by investing through market dips. Consider that a dollar invested in the S&P 500 at the bottom of the market in 2009 is now worth about $3.15, all in less than 7 years' time. A dollar invested a two-week pay period after the bottom resulted in a similar return. You don't have to be a market timer to generate spectacular returns in the long run.
Stocks drop by about 10% every 11 months -- or roughly once a year. In this respect, the current decline in stock prices is very much normal. And whether the recent "correction" becomes a "bear market" is a matter of semantics. For long-term investors, it's an opportunity to go back in time and buy stocks at prices not seen since January 2014.
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