Most investors are still reeling from the steep stock market drop that occurred in January 2016. The brief mini-crash of the summer of 2015 is probably still fresh in everyone’s mind. But, many of the market declines of the last eight years, including the stock market crash of 2008, are becoming faded memories. Certainly, they were hard to go through at the time; but investors who stayed invested throughout that whole period probably can’t complain. That’s because, after every decline, no matter how severe, investors recover their losses. In this case, most investors’ stock portfolios have more than doubled since the market bottom in 2009. The same can’t be said for investors who sell into market downturns hoping to stem their losses. Many who sold their holdings from 2008 to 2009, still haven’t fully recovered, and anyone who sold into any of the subsequent stock market declines has more than likely underperformed the stock market. That may be the most compelling reason to not sell after a market downturn, but the research provides a few more reasons.
If You Don’t Sell It Isn’t a Loss
In down markets investors are often overcome by their “loss aversion” instincts, thinking that if they don’t sell, they stand to lose more money; however, investors can’t actually lose any money unless they do sell. Investors who did not sell during the last big crash or during any of the eight market pullbacks since then, never realized a loss, and they have more than doubled their money. The lesson for investors is there are always down markets, and an up market always follows every down market. The average duration of a bear market is just one-third the length of the average bull market. While the average decline of a bear market is 27%, the average gain of a bull market is over 120%. The key takeaway is that a bear market is only temporary, and the next bull market erases its declines, which then extends the gains of the previous bull market. The biggest risk for investors is not the next 20% decline in the market, but missing out on the next 100% gain in the market.
Most investors are still reeling from the steep stock market drop that occurred in January 2016. The brief mini-crash of the summer of 2015 is probably still fresh in everyone’s mind. But, many of the market declines of the last eight years, including the stock market crash of 2008, are becoming faded memories. Certainly, they were hard to go through at the time; but investors who stayed invested throughout that whole period probably can’t complain. That’s because, after every decline, no matter how severe, investors recover their losses. In this case, most investors’ stock portfolios have more than doubled since the market bottom in 2009. The same can’t be said for investors who sell into market downturns hoping to stem their losses. Many who sold their holdings from 2008 to 2009, still haven’t fully recovered, and anyone who sold into any of the subsequent stock market declines has more than likely underperformed the stock market. That may be the most compelling reason to not sell after a market downturn, but the research provides a few more reasons.
If You Don’t Sell It Isn’t a Loss
In down markets investors are often overcome by their “loss aversion” instincts, thinking that if they don’t sell, they stand to lose more money; however, investors can’t actually lose any money unless they do sell. Investors who did not sell during the last big crash or during any of the eight market pullbacks since then, never realized a loss, and they have more than doubled their money. The lesson for investors is there are always down markets, and an up market always follows every down market. The average duration of a bear market is just one-third the length of the average bull market. While the average decline of a bear market is 27%, the average gain of a bull market is over 120%. The key takeaway is that a bear market is only temporary, and the next bull market erases its declines, which then extends the gains of the previous bull market. The biggest risk for investors is not the next 20% decline in the market, but missing out on the next 100% gain in the market.
You Can’t Time the Market
A look at mutual fund inflows and outflows provides the strongest evidence that most investors think they can time the market. A look at the actual returns of investors who try to time the market shows they are wrong almost 80% of the time. Investors who engage in market timing invariably miss some of the best days of the market. Historically, six of the 10 best days in the market occur within two weeks of the 10 worst days. An investor with $10,000 in the S&P 500 index who stayed fully invested between January 3, 1995 and December 31, 2014, now has more than $65,000. An investor who missed 10 of the best days in the market each year only has $32,665. If a very skittish investor missed 30 of the best days, he has less than $14,000. This is the main reason the average mutual fund investor underperforms the S&P 500 by an average of 8% per year.
It’s Not Part of the Plan
An investor who has a well-conceived, long-term investment strategy should not be concerned with the short-term movements of the market. For someone with a 20-year investment time frame, the stock market crash of 2008 is likely to be a small blip in the long-term performance of his portfolio. The only benchmark that is important to a long-term investor with a strategy is his own investment goals. A sound investment strategy is based on a well-diversified portfolio with a mix of asset classes that keep volatility in check. The only thing needed to manage it successfully is patience and the discipline to stick with the strategy. An investor who has conviction in his own long-term investment strategy is far less likely to follow the panicking herd over the cliff.
Investopedia, By Richard Best, February 11, 2016