US and international stocks declined sharply Friday, June 24 2016, as a result of the British vote to leave the European Union (Brexit).The vote will affect stock and bond markets -- and investor portfolios -- for a long time.There may be further declines and volatility is expected to increase.
The S&P 500 Index declined -3.6% and other US index declines were in the range of -3.8% to more than -4%. European stocks declined more than -7%. Foreign currencies fell relative to the US dollar.
Interesting note: UK stocks (FTSE 100) only declined -3.2%. This year, UK stocks outperformed all other major European markets.
Year to date returns were not as bad:
Shocks like Brexit are a timely reminder that financial markets do not like uncertainty. And the Brexit vote created a lot of uncertainty. Apparently, it will take several years before Britain exits the European Union. No one knows what the terms will be. The overall effect on the British and European economies will probably be negative but by how much? The answers to these and other questions will affect economies and financial markets worldwide.
However, your investment strategy should not depend upon correctly guessing the outcome of the Brexit vote or other events. Your long-term investment strategy should be to invest in a well-diversified portfolio of stocks and bonds, with the diversification based upon your needs and ability to tolerate risk.
When changes are made, investors should try to buy low and sell high. Selling stocks now is selling low. If someone were a brilliant stock market strategist, they would have sold Thursday, not Friday or next Monday.
Sharp stock market declines and daily volatility are normal. As the table below indicates, on average, stock market declines of 5% occurred approximately three times a year, 10% declines about once a year and 20% or greater declines about every 3.5 years.
Historically, larger declines were typically followed by larger recoveries. The average annual five-year rate of return after major declines ranged from 17% to 36%.
One reason many investment professional recommend diversification into bonds (either directly or through a mutual fund or ETF) is to reduce volatility at times like this. Bond markets can and do decline, but the declines are normally much smaller than those experienced by stock markets are.
Another reason to own bonds is to have the opportunity to reallocate some bond investments into stocks when stocks suffer a large loss.
Other points to keep in mind:
- Stocks are a long-term investment.
- Long-term investors have time to recover from declines.
- Your portfolio allocation should have been chosen because it was appropriate for your situation. If your situation has not changed, why change the allocation?
- A natural inclination after a major decline is to sell. Historically, that locked in the loss and eliminated the opportunity to benefit from subsequent increases.
- Investors who sell after a sharp decline rarely reinvest before the stock markets regain their previous values. Those investors found that the more profitable strategy would have been to do nothing, be patient, accept the losses and wait for subsequent gains.
“The [stock] market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” — Warren Buffett.
Looking for good news? Because of the fall in the value of the British pound, it’s now cheaper to vacation in Britain.
Notes: All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. Investments in bonds are subject to interest rate, credit and inflation risk. Diversification does not ensure a profit or protect against a loss. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.