Although market volatility is a completely normal and expected part of investing, nevertheless it tends to stir up people’s nerves. No one wants to take a loss, so when you see the market falling the natural reaction is to want to jump ship. Ironically, this is typically the way to solidify a loss rather than to prevent one. Recent history happens to provide us with a great example. December 2018 saw the market seemingly plummet – quickly. By December 24, the S&P 500 dropped nearly 20% from its September high. So, what would have happened if someone pulled out on that fateful day to try to avoid further market drop?
Let’s say you and your friend Doug each had $100,000 invested in an S&P 500 index fund at the September 2018 high. As the market declined you both would have seen your portfolios go down to about $80,230 at which point Doug panics – he exits the market and stashes his cash in, well, cash. Whew! You decide to stay the course and ignore the market volatility. Low and behold, the next business day the market starts to climb, and with a few ups and downs, continues to climb, until it hits the most recent high which was in July – 26% higher than the December low! (And now in September 2019, we’re currently just points away from that high). At $101,525 your hypothetical portfolio surpassed it’s previous high! Except Doug’s didn’t, he pulled out, remember? So now he’s sitting on the sideline with his $80,000 watching the market soar and he decides what the heck, the market is obviously going up, so he reinvests his loot at the higher share price (Doug now owns fewer shares than he used to). You on the other hand, stayed the course and saw your original value return. Doug took the permanent loss because he reinvested at a higher share price, he will never get those gains back from when he was sitting on the sideline.
The even better news is you continued to regularly invest during the downturn so you bought more shares at a lower price than the previous high, boosting your gains even further.
One of the key things to remember is if you’re looking from year to year, the market goes up much more than it goes down. In fact, despite the ups and downs that happen throughout the year, the market has ended the year positive 33 out of the last 40 years!
Although market timing can seem like a reasonable and safe thing to do in the moment, in reality it ends up being a risky endeavor.
Ultimately, you want to be sure you stick to the financial plan that you set prior to market volatility. Your plan should take into consideration your time horizon and your tolerance for risk. If you’re working with us at Stone Pine Financial, we’ve had in depth conversations about your specific situation and have examined many portfolio scenarios using our planning software. Our best advice to you if you’re ever feeling a little nervous about a market drop and you want to pull out, consider how you might feel if the markets rebounded and you could have recouped all your money and more. Making a decision based on a recent market event often results in a mistake. Any changes you make to your portfolio should be due to changes in your life, not changes in the market. If the market is a little seedy, don’t check your accounts or the bench marks, instead focus on your reasons for saving and investing in the first place – go out and enjoy life!