Everyone knows that losing money hurts. Behavioral finance research suggests that the pain associated with loss is roughly twice as powerful emotionally as the pleasure connected to gains.
It’s important for investors to keep that dynamic in mind during periods of market volatility like the one we’ve seen recently. After a remarkable run for stocks between March of 2020 and early May of this year, markets have hit a bumpy patch. Between May 7 and May 12, the S&P 500 stock index dropped 4%. Since then, it’s been working its way upward.
If you’re a long-term investor who has thought about pulling back from the market until it seems safer, understand that this is a normal psychological response. Humans evolved to avoid perceived danger, after all. Reflexive investment decisions, though, usually hurt more than they help. That’s why self-directed investors so often trail the market.
The good news is that we humans can make rational decisions even in stressful situations. Mastering the markets is largely about mastering our emotions. To that point, consider these six reasons to stay the course when others may be selling.
1. Selling locks in losses. It may feel like your wealth is declining along with the markets, but that is not the case until you sell. As long as you stay the course, the number of shares you own–for AdvicePeriod clients typically low-cost ETF shares—will remain constant. You’ll have the same amount of exposure to markets and thus, the same potential to capture future gains.
2. Downturns have always been followed by upturns. The S&P 500 debuted on Jan. 1, 1957, at 386.36; recently, it stood above 4,000. There have been continual ups and downs along the way, but gains have ultimately far outpaced setbacks. Since 1980, intra-year market drops in the S&P have averaged 14.4%– but the index has ended 31 of those 41 years with overall gains.
3. It’s impossible to predict changes in market direction. No one can foresee the future, and there’s no crystal ball for the markets. The future contains far too many variables to make accurate predictions possible—the best that even the most adept investor can do is guess.
4. Sellers must guess correctly, twice. When we sell in a declining market, we’re betting that the market will fall further. But it’s also possible that the market might reverse course the day after we sell. So what’s the right time to sell? It’s impossible to say. Likewise, it’s impossible to pinpoint the optimal time for re-entering the market. You may jump back in on the day the market begins a long decline. Don’t fall into the trap of thinking the market is like a train that you can exit, and then later re-enter at the same stop. It doesn’t work that way.
5. Missing a few key days can hurt. The market historically has advanced by fits and starts; an index can rise dramatically one day, ease back a bit the next, and so on. Being in the market on the big days can have an outsized impact on your long-term returns, as can being out of the market on those days. If, for example, you missed the S&P’s 10 best days from the beginning of 1999 through the end of 2018, your return would have been cut in half.1 And you might have missed those days, ironically, due to a fear of losses.
6. Compounding takes patience. Einstein called compound interest the eighth wonder of the world, but the magic can’t happen without patience. A simple example: Two investors each have $400,000 invested in the market. Investor A doesn’t touch the money for 10 years, during which time he earns 7% each year. Investor B also earns 7% a year, but after year four, she pulls her money out of the market for a year. She then reinvests her principal and earnings for another four years. In this scenario, Investor A winds up with about $787,000, some $51,000 more than Investor B, or an earnings advantage of 7%. Successful investing is about time in the market, not timing the market.
To be clear, there are legitimate reasons for selling during turbulent markets. One involves tax-loss harvesting, in which losses are deliberately locked in so that they can be used to neutralize taxes incurred on capital gains. Read more about tax-loss harvesting here. We want to avoid selling and staying in cash for a period of time just because we’re spooked.
If you’re an AdvicePeriod client, you have a long-term investment strategy that is carefully aligned with your goals, risk tolerance, and investment timeframe. Setting up your investments is an essential part of our job as your advisors, but equally important is helping you see the big picture and remain patient. Don’t hesitate to reach out if you’d like to discuss your investments or any aspect of your financial life.
1. Michael Aloi “What Happens When You Miss the Best Days in the Stock Market?” Motley Fool, 2019, https://www.fool.com/investing/2019/04/11/what-happens-when-you-miss-the-best-days-in-the-st.aspx