By Robin Bowerman

When sharemarkets around the world are delivering the stomach-churning thrill of a roller coaster ride it is understandable that investors struggle to keep the broad, long-term view of the world in focus.

These periods of extreme market volatility can be stressful for clients and advisers alike but focussing on the broadest frame of reference - such as putting the recent sharemarket losses in the context of your clients' overall wealth including super, their house, even their income, helps investors see short-term events in a longer-term context. Let us look at the recent sharemarket volatility and put it into an historical context - both for the Australian market and the US.

A detailed analysis of Australian sharemarket moves from the end of December 1979 by Vanguard's chief investment officer, Eric Smith, helps set the scene.

Smith looked at all the daily moves that were either up or down by more than 2.5%. When it comes to the positive side of the ledger there have been 37 daily rises above 2.5% since the end of 1979. On the debit side there were 52 days that the market value (as measured by the S&P/ASX200 Index and its predecessor All Ordinaries index) fell more than 2.5%.

Now let's look at the past nine months from August 1, 2007. Given that the first quarter of 2008 has seen the steepest decline in the Australian sharemarket since 1987 it will not surprise anyone to learn that there have been 12 trading days when the market fell more than 2.5%. Easily the worst day was January 22 when the market dropped 7.05%.

But when you look back at sharemarket return histories there is another fact that emerges which tends to surprise people. Big falls and big rises tend to cluster together. It happened in 1987 and it has happened again with the recent turmoil. Take the long weekend in March as a case study. On March 19 the market was up 3.9%. The next day it was down slightly more than 3%. On the next trading day after the long weekend on March 25 it was up 3.7%. These types of shifts highlight how ridiculously difficult it is to try and time markets.

Since August 1 last year there have been 10 days when the market has gained more than 2.5%. The best day was January 25 when it rose 5.02%.

Looking at how the volatility of the last nine months compares in the longer time frame tells us we are in a period of high volatility - 22 of the 90 days since December 31, 1979 that either rose or fell more than 2.5% have occurred since August 2007. So the market data confirms the emotional roller coaster that the markets have been on. But if you look back at the volatility for the previous three years it was historically low. For Australian shares using standard deviation as the volatility measure the past nine months is 16.5%. Look over five years and the measure drops to 10.3% which just underscores how low market volatility had been prior to August last year.

The US market as measured by the S&P500 tells a similar story. After a period of lower than average volatility from 2004 to 2006 volatility increased in 2007 but when you broaden the timeframe to 1970-2007 the annualised standard deviation is 16% - 2002 being a dramatic year with the volatility measure at 26% year.

Extreme market conditions clearly challenge our ability to invest for the long-term. But it is worth considering that the volatility in sharemarket returns is a leading factor contributing to its higher long-run expected returns.

In a market update about sharemarket volatility Vanguard's US Investment Counselling and Research group says that if the risks borne by diversified equity investors are to be rewarded, as they have been historically, then the largest portion of the payoff for that risk might reasonably be expected to follow periods of market difficulty, when the risk of loss may be perceived to be great.

"Over time, risk premiums will vary with the current, as well as the expected, investment environment and lower current prices suggest higher risk premiums and higher relative future returns. While it may be very difficult to capitalise on these shifting risk premiums through tactical allocation a well thought-out strategic asset allocation can serve as a logical anchor for investors, helping to keep them from reallocating their assets in response to volatility," the research update says.

This is supported by the behavioural finance studies that show the time frame people view investing information through can dramatically impact their decision.

One research study shows that if investors are shown market returns on a monthly basis they will typically allocate 40% to equities. However, if investors are shown market returns on an annual basis they will typically allocate about 70% of the portfolio to equities. Short-term market information can make us quite myopic about our investments - potentially to our long-term detriment - an interesting challenge given the easy internet access to portfolio valuations and trading tools.

To help Vanguard investors understand the long-term perspective, our updated market return index chart shows the recent volatility to the end of March. Click here to view.

Market downturns of more than 10% since 1980 have been added along with the time it took to recover to the previous highpoint. For Australian shares there have been seven declines of more than 10% based on monthly returns - and the recovery period has ranged from as short as two months to as long as 63 months post the 1987 crash. The average recovery period is 16 months. The US sharemarket which is such a big driver of international returns tells a similar story with an average recovery period of 14 months.

The listed property market tells a more unusual story - in the past 28 years there has only been one decline of more than 10% before the sector was hit hard in the last quarter last year. Again you have to look back to 1987 for a comparable situation where the property trust market fell 26% and took 38 months to recover.

Sharemarket investors ought to expect one negative year in five. And just as we can never know with certainty what will bring growth markets to an end we also cannot predict what will spark the next growth cycle.

Our Reserve Bank Governor, Glenn Stevens, in a broad-ranging speech in March on market conditions now sees the risk pendulum having swung dramatically to the conservative side.

While he is not downplaying the challenges that still lay ahead "it appears that some very high-quality assets are valued at prices that embody extremely pessimistic assumptions about returns".

"Real savings are still flowing into pension funds, insurance companies and other institutional investment vehicles. This is genuine capital, seeking a productive use. But these investors appear to be taking a more cautious approach to risk, given the short-term uncertainty over asset valuations," Stevens says.

Leverage and the lack of transparency around complex derivatives have compounded and clouded the recent market volatility. If there is one lesson investors can learn from the recent turmoil it is that the smart way to invest is to keep things simple and understand what you are investing in and the risks you are taking. That and looking at your investments through the widest angle lens you can find.