A Word on Volatility

What in the world has happened to the stock market?

When I first started about thinking about saving for retirement in my 30s, the standard line repeated over and over by investment counselors was that the stock market was the best choice because in the long run it provided about an 8% annual return, better than bonds or cash.

Consider this chart, which portrays S&P 500 performance since 1950.

As you can see, with minor deviations the 8% rule held until the mid 1990s. Then something crazy happened: extreme volatility. First, there was the "irrational exuberance" of the .com bubble and the inevitable crash. Then there was a rapid recovery until the 2008 financial crisis, which resulted in an even bigger crash. Since the 2008 meltdown, there was yet another rapid recovery until 2010. Since then, returns have been more modest, and we have yet to reach the 2007 peak.

Since the 1999 and 2007 peaks were both considerably above the 8% trend line, a correction was perhaps expected. The question is: Now that we are below the 8% trend line, what happens now?

If we are to resume the 8% annual rate of return, then the market should double in the next 10 years--a strong argument for investing in stocks. On the other hand, one can't help but feel like the old rules just don't apply any more.

Like Arthur Jensen in Network, I don't like volatility. I am sticking to bonds, which give a boring, but predictable rate of return considerably below 8%.