Today’s big stock market drop might feel alarming, but it’s a normal part of the equity landscape, in other words, it’s business as usual. Volatility—those sharp ups and downs in stock prices—is not a glitch; it’s part of the system and should be expected. It’s the price investors pay for the far superior long-term returns that stocks deliver compared to cash and bonds. History shows that while cash and bonds can offer stability, they dramatically lag behind equities in wealth creation over time, precisely because they avoid some of the volatility that stocks endure.
Consider just 3 examples (although there are many more):
- On October 19, 1987—Black Monday—the market plunged 20.4% in a single day, the largest one-day drop in history. Panic ensued, yet those who held firm saw the index up over 22% from the bottom just one year later, two years later the market was up over 54% from the bottom, and over the next decade, the market more than tripled (3x). That volatility was the entry fee for outsized gains, far exceeding the 4-5% annual returns of Treasury bonds or the near-zero yield of cash during that era.
- 2000-2002 Dot Com: The Nasdaq fell 78% from its peak, yet returned 72% within the next year, and 151% over the next 5 years. Bonds and cash? They chugged along at 5% and 1%, respectively. Volatility shook out the faint-hearted, but those who stayed the course captured exponential growth.
- 2008-2009 Financial Crisis: The S&P 500 pulled back 56.8% from its 2007 peak to its 2009 trough. Bonds and cash looked tempting as havens, with 10-year Treasuries yielding 3-4% and cash at least preserving principal. But equities roared back, and returned more than 60% over the next year, 84% over the next 2 years, and nearly tripled (3x) over the next decade. Meanwhile, bond returns averaged 4.5% and cash hovered below 1%. The drop was, again, the cost of admission for equity investors who reaped the rewards.
- Bonus example, the Covid scare: The Dow was down over 37% in 5 weeks, bottoming in late March 2020. What happened just 1 year later? The Dow was up 74% from the bottom, up 84% in two years, 125% over the next 5-years, the S&P 500 and Nasdaq did even better.
Why do stocks outperform?
They’re tied to companies that innovate, grow, and adapt—unlike bonds, which lock in fixed payments, or cash, which erodes with inflation.
I’ll admit that cash and bonds have a place in a lot of investors’ portfolios, keep in mind, growth will come from owning stocks. Today’s drop, however jarring, is just noise in that long-term signal. Volatility isn’t a bug to fear—it’s the engine that drives equity investors to greater heights. History proves it, when investors own good companies, the payoffs are massive for those who can ride out the short-term swings.
-Paul R. Rossi, CFA