August’s stock market decline is a good thing

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This is all very normal
Stock market ups and downs are normal

Investors might get an unpleasant surprise when they review their August investment statements.

Stock markets around the world lost money. Many investors will be disappointed with their own financial results.

Europe and Asia were the hardest hit. Their stock markets declined slightly more than 10% during the month of August. The United States and Canada had less drastic declines.

During the month of August the U.S. stock market declined 6.1 per cent while the Canadian market was down 4.2 per cent.

We fared better than the United States last month, however during the last 12 months our stock market has declined 11.3 per cent while the US has declined just 3.3 per cent.

Why are investors losing money? Should you be out of the market? These questions are asked when stock markets decline in value.

The real question is what happened? The answer is simple …nothing happened. This is all very normal.

August stock market Peter Watson InvestmentsNot only is this type of market decline normal, it is essential if you hope to make money in the long term. We should all re-frame how we evaluate last month’s decline as something good, not bad.

Just to be sure this point is clear, it is my opinion that last month’s decline in value in the stock market is a good thing. Here is the reason why.

The various types of investments available have a return that is based on the risk of those investments. Risk is most often measured by the amount of volatility in prices over a given year.

A Government of Canada bond does not have the same risk of decline as the stock market. In other words, government bonds are less risky than the stock market.

Less risky investments pay lower returns. If the stock market had the same low risk of price decline as government bonds then stock market investments would also have a less attractive return rate.

In the long-term investors are rewarded for taking risks. Stocks are far better investments than bonds.

That’s the easy part. It is a simple case of Investments 101. Risk and return are related.

In a perfect world investors would welcome periods of stock market decline realizing that in the long-term they will do just fine. Unfortunately that’s not always the outcome.

The reality is many investors and their investment advisors believe the market is something that can be predicted in the short-term. This is a wonderful idea however there is no evidence that suggests this can actually happen.

What does happen is people panic when markets decline and sell their investments. They try to keep their money safe and do not have the courage to re-invest in the stock market until the market has appreciated in value.

Investors self-destruct by selling at a loss and then do not participate in market recovery. Stock market investing has been around for over 200 years. In that entire time markets have always regained losses and gone on to set new highs.

Markets recover. Investors do not.

Our recommendation to investors is to take a long-term perspective and not to panic when stock markets perform poorly.