You wouldn’t be human if you didn’t fear loss. As such, an investor’s natural instinct is to flee the market when it starts to plummet, just as greed prompts us to jump back in when stocks are skyrocketing. Both can have negative impacts.
1. Market declines are part of investing
Stocks have risen steadily for nearly a decade. But history tells us that stock market declines are an inevitable part of investing. The good news is that corrections (defined as a 10 percent or more decline), bear markets (an extended 20 percent or more decline), and other challenging patches haven’t lasted forever. The Dow Jones Industrial Average has typically dipped at least 10 percent about once a year, and 20 percent or more about every 3.75 years, according to data from 1900 to 2017. Each downturn has been followed by a recovery and a new market high.
2. Time in the markets matters, not market timing
No one can accurately predict short-term market moves, and investors who sit on the sidelines risk losing out on periods of meaningful price appreciation that follow market downturns. The average return in the first year after each of these market declines was nearly 55 percent. Even missing out on just a few trading days can take a toll. A hypothetical investment of $10,000 in the S&P 500 made in 2002 — the start of the recovery following the bursting of the technology bubble — would have grown to more than $18,000 by the end of 2012. But if an investor missed the 10 best trading days during that period, he or she would have ended up with just $9,378 — less than the initial investment.
3. Emotional investing can be hazardous
Emotional reactions to market events are perfectly normal. Investors should expect to feel nervous when markets decline. But it’s the actions taken during such periods that can mean the difference between investment success and shortfall.
4. Make a plan and stick to it
Creating and adhering to a thoughtfully constructed investment plan is another way to avoid making shortsighted investment decisions — particularly when markets move lower. The plan should take into account a number of factors, including risk tolerance and short- and long-term goals. One way to avoid futile attempts to time the market is with dollar cost averaging, where a fixed amount of money is invested at regular intervals, regardless of market ups and downs. This approach creates a strategy in which more shares are purchased at lower prices and fewer shares are purchased at higher prices. Over time, investors pay less, on average, per share.
5. Diversification matters
A diversified portfolio doesn’t guarantee profits or provide assurances that investments won’t decline in value, but it does lower risk. By spreading investments across a variety of asset classes, investors lower the probability of volatility in their portfolios. Overall returns won’t reach the highest highs of any single investment — but they won’t hit the lowest lows either.
6. The market tends to reward long-term investors
Is it reasonable to expect 30 percent returns every year? Of course not. And if stocks have moved lower in recent weeks, you shouldn’t expect that to be the start of a long-term trend, either. It’s natural for emotions to bubble up during periods of market volatility. Those investors who can tune out the news are better positioned to plot out a wise investment strategy.