Playing The Long Game

The news headlines continue to be dominated by the coronavirus and its impact is being felt everywhere not just in financial markets but in everyday life. Markets are highly volatile and despite central bank intervention, things appear to be getting worse before they can start to get better. We are all exposed to the markets in different ways and it can feel like there is nowhere to hide when markets are plummeting. That being said, it pays to play the long game and not react to short-term events.

Pursue FIRE Playing The Long Game

It’s human nature to feel concerned when you look at your pension or ISA balances and see them 20-30% down on where there were just a few weeks ago. While I’ve lived through a few market crises in my life and know better than to panic, I’m still as guilty as anyone at checking to see how much damage has been done. Checking just my pension balance this morning, I can see it has dropped over £60k since mid-January. Ouch! 🙁

Annual Swings

While nobody can predict where markets will move to during the remainder of 2020 and beyond, it certainly now seems unlikely that we will be in positive territory by year-end. But that is just a hunch rather than anything concrete for I am no better skilled at anyone at predicting the unpredictable.

Regardless of what occurs from here, positive or negative, will the current coronavirus shockwaves still be reverberating around markets and in our thoughts in 5-10 years from now?

Indeed, looking at calendar year returns for the FTSE All-Share Total Return Index above (a key benchmark equity index for the U.K.) you can see that there have been both some spectacular up years and some painful down years too.

While we are barely through the first two months of the New Year, as it stands, 2020 thus far (as at the end of February) would shape up to be among the worst return periods in the past 30-years, behind the credit crisis in 2008 (-30%) and the explosion of the bubble in 2002 (-23%) if the year was to end today. Even worse, as I write this on the afternoon of the 12th of February the index is down -21% year-to-date in 2020.

There is obviously a long way to go still in 2020, but looking at these annual returns in isolation may inject a sense of fear or reinforce the feeling that investing in equities is risky business. It’s certainly not without some risk, but no meaningful returns can be achieved over time without taking on some equity risk.

Short-Term Shocks vs. Long-Term Gains

Let’s look at those headline annual market returns in a different way. Dropping them into my heatmap grid below (running from left to right along the top row), we hopefully gain some comfort that the long-term game continues to play out.

So, running along the top line from left to right are the annual returns over the past 30 years for the FTSE All-Share Total Return Index in GBP. I’ve also added the partial, year-to-date return for 2020 (through the end of February) for the index at the far right at -12%. Obviously, March has seen things deteriorate somewhat further as already mentioned, with the index now down over 20%.

So, with annual returns running horizontally across the grid, looking vertically, the numbers reveal what the compound annualised returns would be over time had you invested at the start of each year. Cells are colour-coded by their return size, so the darker green cells represent higher returns, through to the darker red cells, which represent the worst returns.

Take a moment to look at the chart and consider what patterns you see?

Looking purely at the heat map and the evolution of the colours, it should reveal to you that the further you move down the page from the starting given year (i.e. the longer you invest and compound returns for) the less volatile those annualised returns become.

I’ve written before about this concept before

Indeed, looking at the final cell in each column (each column being the starting year) you’ll see a remarkably consistent long-term annualised return, whether it is over a 30-year time frame (starting all the way back in 1990) at 8% or a shorter-term period of 5-years (starting in 2014) also running at 8%. Depending on where you choose to examine in between, the long-term annualised returns and rewards for staying the course range from 4% at the low end to as much as 10% at the high end. All this despite the various and sometimes wild monthly or annual swings of the market over the past 30 years.

Here is another chart that plots the rolling 1-year return of the FTSE All-Share Total Return Index (monthly observations) in the red line against the longer-term rolling 10-year returns in blue. Short-term noise versus long-term consistent gains.

2008 Sub-Prime Example

So, for example, let’s take the worst individual calendar year return over the past 30 years from the grid – that being in 2008 when the market in the U.K. fell 30% over the year as a result of the sub-prime credit crisis and subsequent market turmoil.

I’ve lived through a few market shocks now in my 43 years (tech bubble, 9/11 etc) and the 2008 crash was certainly a very worrying time. Working in the financial services industry, I was acutely aware of the implications a potential banking collapse would have on the wider economy and of course we saw many financial firms go under, including Lehman Brothers. Somehow I managed to avert the widespread redundancies that followed across much of the sector.

Over the years that followed, markets, of course, recovered as they always do (looking right from 2008 in the grid) and this helped to both recoup 2008 losses and lift longer-term annualised returns back towards the averages we have come to expect over time (typically in the 6-8% range).

So, had you unluckily invested at the start of 2008, and suffered the 30% market drop that year you would be rightly concerned and debating whether to stay invested or cut your losses. However, had you stayed the course and remained invested, the annualised compound returns would have turned positive within 3-years, and then reverted to a 6% annual compound return through the end of 2019 (a 12-year period). Note, that this period also included another, albeit a less severe, market drop of -10% in 2018.

Expansion versus Contraction

Another helpful long-term perspective is to view overall returns in the context of market expansion (i.e. periods of positive return) versus market corrections (i.e. periods of market decline).

The chart below shows the FTSE All-Share Total Return Index in GBP, again over the same 30-year lookback period. Here I’ve highlighted the various market corrections (which I’m defining as a drop of 10% or more) in orange. Contrast these to the periods of market expansion, highlighted in green. Note, that a bear market is usually defined as a drop of 20% or more.

What becomes quite evident is that markets correct meaningfully quite regularly (less than 10% declines are even more common) but that this does not deter from the long-term upward trajectory. What the chart also demonstrates is that material corrections of 10% or more, tend to be brief and that they are typically followed by periods of strong and prolonged market expansion. This is the chief argument against trying to time the market. You can see that (as of the end of February) the FTSE All-Share Total Return Index has fallen greater than 10% and so the current ‘correction’ is drawing on the chart at the far right side.

The last 5 worst individual years – had you invested

Lastly, let’s consider what would have happened in each of the negative years the FTSE All-Share Total Return Index experienced over the past 30 years. Below, I list the individual down years and the negative returns that occurred, followed by the degree to which the markets then recovered in the subsequent 1, 3, 5, 7 and 10-year periods.

As before, the longer the time period, the greater the individual shocks dissipate into history.

To take the most positive example, had you invested at the start of 1990, you would have faced a -9.7% decline in the first year. The following year (1991), the market recovered +20.8%. Taking that initial down year into account, the 3-year annualised return (i.e. 1990-1992 inclusive), had jumped up to +9.5%; +9.7% over 5-years; +12.6% over 7 years and +14.9% over a 10-year period. An initial £1,000 invested in 1990 would have grown therefore to £4,008 over the full 10-year period despite that losing the first year and another -6% year in 1994.

Taking the least positive example, had you invested at the start of 2000, you would have faced a -5.9% decline in the first year. 2001 and 2002 were also down years of -13.3% and -22.7% respectively. Over that first three years, you’d have suffered an annualised -14.2% return and the starting £1,000 investment would have been reduced to £631.

Taking that into account, the 5-year annualised return (i.e. 2000-2004 inclusive) would have improved to -3% and by 7-years it would have again turned positive at +3.0%. Over 10-years it had dropped back to +1.6%. While this is nothing to write home about, it was the worst period to have started investing in the past 30-years and you’d still have a positive return had you rode out the early losses.

A U.S. View

I’m conscious that these are all U.K. based examples. However, regardless of where you look the story is largely the same as periods of heightened market volatility tend to result in highly correlated market moves across the world. For comparison’s sake, here are the same charts as laid out before, but this time for the S&P 500 Index Total Return Index in U.S. dollar terms.

The Annual Returns of the S&P 500 Index in US$
Long-Term Return Heat Map for the S&P 500 Index in US$

As with the U.K., the long-term annualised returns for the equity market revert to fairly stable 7-10% over time, despite the individual ups and downs one might observe in any given year.

Rolling 10-year Annualised Returns present a much calmer picture than rolling 1-year returns
S&P 500 Index Market Expansions vs. Corrections

The U.S. equity market has tended to have longer bull runs than many other equity markets around the world. Here you can see that, over the same 30-year period, there have been far fewer market corrections of 10% or more. When they have occurred, they have also been followed by prolonged periods of market expansion. Note that, as of the end of February, the S&P 500 Index had only declined 8.3% from its peak, so the far right of the chart is yet to show a correction environment (I suspect March will tip the S&P over the 10% drop line)

Final Thoughts

While it remains a difficult and challenging period for investors, particularly for those experiencing their first major market correction, hopefully, the longer-term view above gives some confidence that we have been here many times before, and that, there is no need to panic. If like me, you have at least another 10+ years before you are likely to need your retirement or savings funds, it is my belief that 2020 will fade into the history books along with prior crises.

Don’t panic, stay invested and focused on playing the long game and you’ll continue to be rewarded over time.

Thanks for reading


This Post Has 4 Comments

  1. weenie

    Great post, Dan. Whilst the numbers and data provide little comfort while we look at the sea of red in our portfolios, we must just remain patient and not panic!

    This might all mess up my FIRE plans but only in terms of when I pull the trigger – I will still end up giving myself the best shot of having a comfortable retirement, even if I end up retiring later than planned.

  2. Pursue FIRE

    Cheers Weenie – as Warren Buffett always says “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

  3. SouthWalesFI

    Excellent post- I was considering writing something similar, but you have already done it. Yet- some people must be selling, and they will forever be telling their friends that they lost out on “the stock market”

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Hello and welcome to Pursue FIRE. My name is Dan and I am the owner and author of all content on this site. I am passionate about personal finance and look forward to engaging with you.
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