Stock Market Turbulence – A Good Thing?

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The market has been a bit unstable over the past few weeks, how can this be a good thing? The answer lies in what economists refer to as the “equity (stock) risk premium”. This is their way of explaining why stocks have historically returned 6.6% annually (after inflation) while bonds have returned 3.6% (Siegel, 2014, p. 6). The extra 3% that stocks have returned is the “premium” that economists figure is required for investors to be attracted to a market with sometimes wild swings. Put another way, the stock market hasn’t had returns of 6.6% in spite of it’s ups and downs, it’s had these returns because of the ups and downs! If the market didn’t experience occasional turbulence then it would be more likely to earn returns closer to what bonds pay. Therefore, for long term investors, turbulence is good news. It keeps the short term and weaker players out of the market and has historically kept prices at a level that allowed for a higher long term growth rate than bonds.