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Roller coaster stock markets have investors feeling queasy

'I'm not getting on that roller coaster!" is a common cry of late among stressed out investors, traumatized by another neck-snapping week of ups and downs in the stock market.

Stock market volatility is one of the many causes for investor concern these days. By any measure -- daily, weekly, monthly, quarterly -- the recent past has seen fluctuations at record highs.

Unfortunately, we are not likely to see an end to turbulence any time soon. Technology -- which disseminates information in a split second and allows instantaneous trading at minute cost -- makes it possible for a whole new squadron of nimble hedge fund investors and the principal trading desks at many large brokerage firms to extract short-term profits from a flurry of lightning-fast trades.

Then there is the way in which most stocks are now valued. Even after the correction of the past few years, most stock prices reflect earnings into the distant future. So, even a slight correction in forecast earnings has a big impact on the share price. This is in stark contrast to the traditional drivers of share value -- factors such as hard assets and dividend payouts that are more concrete and less changeable.

What you end up with is a witch's brew of factors, which regularly sends stock markets on a roller coaster ride of extreme ups and downs. Should investors be concerned about these fluctuations?
The sleep-at-night quotient

The answer -- as is so often the case -- is both yes and no.

Today's volatility can be a real concern if you are living off your savings or need money in the relatively short term -- say the next three years -- to fund the purchase of a new house or car, or to pay for university. There is nothing worse than having to sell when the market's in one of its periodic dips.

Volatility can also be a problem if you have difficulty sleeping at night when the value of your investments has dropped -- even though you have no need to sell. Peace of mind is an often overlooked consideration in making investment decisions.

Short-term volatility is of much less concern to the majority of investors who have a relatively long time frame and the disposition to live calmly through the ups and downs. There is, in fact, ample evidence that the longer your time frame, the less that short-term turbulence matters.
The ups and downs of returns

The one-year chart on this page shows annual returns each year since 1946 for the 500 stocks that make up the Standard & Poor's 500 total-return index, considered the best measure of what's happening to the value of large companies in the United States. These include both dividends and changes in stock prices.

The ups and downs on this chart -- with extremes ranging from a gain of 53 per cent in 1954 to a loss of 26 per cent in 1974 -- epitomize what scares many investors. The variation in returns on an annual basis -- from high to low -- has been 79 per cent.

Using the same numbers, the second chart shows the average compound return over moving five-year periods -- from 1946-50, 1947-51 and so on. Here we see a somewhat different picture. The period with the highest return was 1995-99, when the average annual increase was 29 per cent. The five-year period with the worst returns was 1970-74, when stocks lost an average of 2 per cent a year. The variation from high to low was 31 per cent.

The third chart reflects the same calculation for 10-year periods. The best return was 1949-58, when returns averaged 20 per cent a year. The worst was 1965-74, when stocks returned an average of 1 per cent. The variation from high to low was 19 per cent -- and note that there was no 10-year period in which large stocks lost money.

The final chart depicts the returns for 20-year periods. That is not your time frame if you're on the verge of retirement, but probably not far off the mark if you are 45 or 50. (One impact of rising life expectancy is that investors' time frames will have to become longer.) The best 20-year return was an average of 18 per cent for 1980-99. The worst was 7 per cent for 1955-74. The variation from high to low was 11 per cent -- admittedly a large number, but nothing like the 79 per cent if you're looking at one-year returns.

Of note: Seven per cent was the worst that you did as a long-term investor since the Second World War.

There's an old axiom that time is an investor's friend, and lack of it the enemy.

With the possible exception of the small number of speculators looking to profit from quick swings in stock prices, no one likes market fluctuations.

But investors with a time frame of 10 years or more and the emotional fortitude to look past short-term turbulence should see volatility for what it is -- the price required for the higher long-term returns that the stock market has almost always provided.
Dan Richards is chief executive officer and Marc St-Pierre is chief investment officer of Cartier Partners Financial Group, Canada's largest network of independent financial advisers.

© The Globe and Mail

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