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1 Important Fact about the Share Market You Must Know

The act of looking back at the history of the share market might be construed as some to be pointless when it comes to investing. But the thing is, there’re still very important benefits we can glean from peeking at the rear-view mirror.

One such benefit was recently highlighted by my US colleague Morgan Housel in his column with the finance publication The Wall Street Journal:

“One key to keeping a cool head during market drops is realizing how common they are. If you don’t understand how normal big market moves really are, you are more likely to think a pullback is something unusual that requires attention and action. It often doesn’t.”

The importance of knowing how violent the market is

That lack of context in terms of how violent share price movements can be seems to be a strong reason why investors often tend to underperform the market.

For instance, in the 20 years ended 2013, the S&P 500 (a widely followed market barometer in the USA) had achieved annualised compounded returns of 9.22% while the average mutual fund investor only managed to earn 5.02% per year. A $10,000 investment compounding at 9.22% per annum would turn into $218,000 in 20 years; at 5.02% per year, the same starting investment would have an ending value of just $26,000.

A big source of that gap in returns stems from investors’ propensity to buy and sell shares at exactly the wrong times. They chase returns when the market’s doing well, and flee in droves when the markets turn south.

So how violent can the market be?

Between 11 April 2002 and 31 August 2014, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which aims to mimic Singapore’s market barometer the Straits Times Index (SGX: ^STI), has delivered annualised capital gains of 5.35%. That can fool an investor into thinking the market has been climbing smoothly upward.

But, the actual movement in the market is anything but smooth. Consider the following chart, which plots out the spread between the highest and lowest close for the Straits Times Index in each calendar year in the 20 years ended 2013:

high-low chart for STI

Source: S&P Capital IQ

When the highest close in a calendar year can be 116% higher than the lowest close (which happened in 2008), it’s easy to see how volatile the share market in Singapore can be.

Foolish Bottom Line

If you’d like to earn a 5.35% annual return from the share market over the long-term in capital gains, then bear in mind the amount of volatility which can happen in any given year. Shares are prone to big drops from time to time, but that doesn’t mean that there’s anything fundamentally flawed or broken with the share market. It’s just the same as it always was.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.