In October 2007, the stock market reached a high. During the 18-month decline that followed, ending in April 2009, the market lost more than 56.78 percent of its value (as measured by the S&P 500 index). This resulted in a housing crisis and a crippling 10-percent unemployment rate, the lowest level since early 1997. Then, from the bottom in 2009, the stock market recovered, rising more than 215 percent by April 2015.
Investors, feeling they had missed out, began to reenter the market, only to be blindsided when volatility came back with a vengeance. From July 2015 to the middle of August, the market experienced an 11.16-percent decline. On Aug. 24, the Dow shifted more than 4,890 points. As of September, that number was over 10,000 points. So, yes, market volatility is here and probably here for a while.
What’s an investor to do to weather the storm? Perhaps now is the time to think of passive versus active investing. Proponents of index investing simply focus on fees, but I believe there are other factors to consider.
Think of it in terms of sailing versus rowing. If you are sailing and the seas are calm with the wind at your back, the fastest way to get to your destination is to roll out the jib. Sailing is index investing; I agree it works best in a rising market. But when the seas get rough and the wind shifts, any smart sailor will drop his or her sails and begin rowing so as not to blow too far off — hence, active management.
Historically, active managers have lagged behind benchmarks during long and strong bull markets, when security selection makes less of a difference. However, they tend to add value and make up that lost ground when markets level off or suffer corrections. (Again, it’s like sailing versus rowing.)
The S&P 500 is a market-capitalization index, which means the largest companies contribute a larger percentage of the return as well as the risk. As the markets increase, so does the risk. In 2014, five companies represented 11 percent of the index return, despite the fact that none of those companies was among the top 10 stocks.
During the tech boom of the 1990s, technology represented 34.5 percent of the S&P 500. It fell to the bottom in 2002, representing only 12.3 percent of the index. Financial stocks represented 22.3 percent of the index in 2006 and 8.9 percent at the bottom in March of 2009.
Investing in the S&P 500 at the peak of a market cycle is like speeding up going into an intersection rather than slowing down. Therefore, rather than abandoning a good strategy and jumping out of the market during volatile times, perhaps a little tweaking and moving from passive index investing to more actively managed investing could be the solution — keeping you on track and keeping your portfolio from blowing off course.
John E. Girouard, author of “Take Back Your Money” and “The Ten Truths of Wealth Creation,” is a registered principal of Cambridge Investment Research and an Investment Advisor Representative of Capital Investment Advisors in Bethesda, Maryland.