For many of us, the market declines of the recent past, including the stock market crash of 2008, are becoming faded memories. In the end, those who stayed invested during these difficult times perhaps came out in the best shape.
Market crashes and economic downturns are part of life. As the COVID-19 pandemic showed, market calamity can occur seemingly out of nowhere. What's important is how investors handle that calamity. Do not despair. Do not let emotions such as fear and anxiety drive you to sell rashly into a falling market. Keep enough cash available so that you're not forced to sell your investments to get it.
Cash flow management plus an understanding of the markets is paramount in such circumstances. Here's why. After every decline in history, no matter how severe, investor portfolios tend to recover from their loss in value. Markets begin to stabilize and see positive growth over the long run.
You can stay invested and even accumulate more shares when prices are low. These opportunities aren't available to investors who sell during market downturns, hoping to stem their losses and wait things out on the sidelines.
Below, we go over three solid reasons not to sell during a market downturn.
- A market crash can cause a lot of fear and anxiety as portfolio values fall and volatility rises.
- You may be tempted to sell your holdings and sit out the market downturn.
- That tactic could mean selling low and missing future price increases.
- It's vital to understand that market downturns will happen and they will end.
- Planning is key to keeping fears at bay and preventing real losses due to selling prematurely.
1. Downturns Are Followed by Upturns
In down markets, investors understandably can be overcome by their loss aversion instincts. They think that if they don't sell, they stand to lose more money. However, the decline of portfolio value normally won't last. Prices will go back up.
If investors sell when the market is down, they will realize an actual loss. A lesson many investors have learned is that if they sit tight and wait for the upturn to come, they won't realize a loss. In fact, they may even see their portfolios gain more value than they had before the downturn.
It can be challenging to watch market prices decline and not pull out. However, research shows that the average duration of a bear market is about one year, compared with approximately four years for the average bull market. The average decline of a bear market is 30%, while the average gain of a bull market is 116%.
The important thing to remember is that a bear market is temporary. The subsequent bull market erases its declines and can extend the gains of the previous bull market.
The big risk for investors is missing out on the major gains in the market to come. While the past is not a predictor of the future, it should provide some assurance that what goes down does tend to go back up.
Some investors may be close to retirement and don't have the luxury of time to ride out periods of market volatility. However, their portfolios should be adjusted for a more conservative asset mix to protect against volatility and other risks.
2. You Can’t Time the Market
Timing the market is incredibly difficult. Investors who engage in market timing invariably miss some of the best days of the market. Historically, six of the ten best days in the market occurred within two weeks of the ten worst days.
According to J.P. Morgan, an investor with $10,000 in the S&P 500 Index who stayed fully invested between Jan. 4, 1999 and Dec. 31, 2018 would have gained about $30,000. An investor who got out of the market and therefore missed 10 of the best days in the market each year would have under $15,000. A very skittish investor who missed 30 of the best days would have less than what they started with—$6,213 to be exact.
As a result, instead of selling on the way down, try buying. Accumulating more shares in a regimented way, even as stocks fall, allows you to dollar cost average and build your portfolio with a lower cost basis.
3. The Plan Is to Stay Invested
Long-term investors with a 20- or 30-year investment time horizon who remain invested despite drops in the market most likely will see a smaller negative effect on their portfolio values than investors who sell during downturns and get back in later.
The stock market crash of 2008. The market downturn after the Brexit referendum in 2016. These events weren't pretty. However, what's important for long-term investors is staying true to their investment goals and a sound investment strategy. A well-diversified portfolio with a mix of asset classes can keep volatility in check.
If you keep the focus on your long-term investment strategy, emotions like fear and greed shouldn't affect your course of action. If you contribute a certain amount to your portfolio each month, keep doing that despite market ups and downs! If your target allocation is 80% stocks, 20% bonds, re-allocate when stocks drop to restore your target weights at a relative discount.
What's the Longest Bear Market in U.S. History?
The bear market of 2000 to 2002 was 2.5 years long. The next longest was the 1930 to 1932 bear market which lasted 2.1 years.
What's the Biggest U.S. Bear Market Drop?
From 1930 to 1932, the stock market dropped 83% over 2.1 years.
How Can Investors Maintain Calm During Bear Markets?
It can be difficult because emotions can hold powerful sway over our actions. However, here are a few suggestions. First, when you begin investing, be sure to put a plan in place that, along with detailing your goals and investment strategies, instructs you to stay the course in the event of a drop in prices (short term or prolonged). Second, remind yourself that bear markets always come to an end. Third, avoid the frightened and sometimes desperate chatter coming from news outlets and elsewhere online. Finally, turn to a trusted financial advisor with market experience for calming advice.
The Bottom Line
Having the patience and discipline to stick with your investment strategy is vitally important in successfully managing any portfolio. If you have a long-term investment strategy, you'll be far less likely to follow the panicking herd over the cliff.
Instead of fear-based selling, use a bear market as an opportunity to buy more. Accumulate shares at deep discounts if possible and allow yourself to diversify. Your portfolio will be better positioned for growth when things eventually turn around.