Investing Strategy When the Stock Market is Volatile: Time In vs Timing the Market
The stock market is off to a rocky start this year. Higher volatility can be a source of uncertainty for even the most seasoned investors. In this issue we hope to provide some historical perspective on the anatomy of the markets and the impact of moving out of markets during periods of turbulence.
Volatility is a Feature, Not a Bug, in the Stock Market
History tells us that market volatility is a feature of how the market functions and not a bug. Research by Ned Davis on the anatomy of the stock market (Dow Jones Index) highlights the frequency of market declines since 1900[i]. This research found that on average, every year the market suffers three 5% corrections, one 10% correction, and a decline of 20% every three years or more. Market history also suggests that most dips (declines of 5%) in the Dow Jones Industrial Average don’t turn into anything serious.
Time in Versus Market Timing
Since market pullbacks are frequent, avoiding just a few of them could potentially add to investment results. However, attempts to avoid pullbacks more often lead to missing out on significant advances. A reason is that market volatility is often clustered with the big moves in the market, both up and down, occurring within days of each other.
As an example, an investor who remained fully invested in the S&P 500 Index during 2020 saw a total return of 18.4%. On the other hand, if an investor sold when the market dropped, not only would they have possibly avoided some of the losses, but they could have also potentially missed the trading days with the greatest gains. Research shows that simply missing the top 10 trading days in 2020 would have led not only to giving up the gains, but an investor would have experienced a loss of 32.9%[ii].
Source: Schwab Center for Financial Research
This phenomenon is not isolated to 2020. Over the last fifteen years, a time period which includes the great financial recession, as well as the COVID-driven recession, an investor who remained invested in S&P 500 index would have generated an annualized return of 10.66%. However, simply missing the top 10 days would cut returns by 50% to 5.05% annualized returns. The results become more dramatic when simply missing the top 30 days leads to annualized losses of -1.18%.
How Do Fluctuations in Your Investment Portfolio Make You Feel?
Before you can control your emotions, you must get in touch with how you feel. Many folks equate their self-worth with their income, magnifying the pain caused by market losses or the failure to capitalize on investment opportunities. As the market fluctuates, take stock of your emotional reactions and the resulting impulses to buy or sell securities.
Concentrating on minute-to-minute returns can feed all sorts of unhelpful emotions. It takes discipline to resist the current herd mentality or become impatient when your returns don’t measure up right away. Volatility can be scary, but it’s worth noting that the S&P 500 Index Market Returns made an annual gain in 28 of the last 34 years.1
Avoid making hasty investment decisions as they could lead to untimely buying and selling. A better strategy is to set your asset allocations logically, based upon your goals, age, and tolerance for risk. You can then periodically rebalance your portfolio to maintain your allocation proportions.
Keep in mind, past performance is no guarantee of future results.
Another Idea to Help You Stay the Course
Let dollar-cost averaging (DCA) defang your emotions. DCA is an effective way to reduce the guesswork and risk in trying to time the market. The tactic is to invest equal amounts at regular, predetermined intervals. In this way, you’ll buy more shares cheaply during downtrends and fewer expensive shares during uptrends. The key to success using this tactic is to stay on course.
The Key to Long-Term Investing Success
Understandably, the market’s normal ups and downs can be stressful. While it’s natural to have a reaction to market volatility, it’s also important to understand the potential impact of that reaction as well.
One of the most common mistakes investors make is to go on a buying spree when the market is topping out (and the headlines are positive) but then selling at the bottoms (when headlines are negative). With a bit of discipline, you can avoid the emotional traps that can result in poor investment decisions.
The key to long-term investment success is the decision to be invested and to stay invested.
Still Feeling Nervous About Stock Market Volatility?
You aren't alone. A life-focused financial planner can help teach you how to invest with your brain instead of your gut. If it feels like it's time to talk to someone, please reach out to me for more information on the helpful role a financial planner can play in your financial life story.
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 Putnam Investments: Time, not timing, is the best way to capitalize on stock market gains. 12/31/06-12/31/21 [i] Ned Davis Research: The Anatomy of the Stock Market (DJIA) declines from 1900. Data: 1/02/1900-2/14/2022 [ii] Charles Schwab: Is there a perfect time to invest? Bah! Humbug! Results are based on daily total returns from 2020, from the first trading day of January 2020 to the last trading day of December 2020.
This is for informational purposes only, is not a solicitation, and should not be considered investment, legal or tax advice. The information in this report has been drawn from sources believed to be reliable, but its accuracy is not guaranteed, and is subject to change. Investors seeking more information should contact their financial advisor.
Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss. Actual client results will vary based on investment selection, timing, market conditions, and tax situation. It is not possible to invest directly in an index. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Index performance assumes the reinvestment of dividends.
Investments in equities, bonds, options, and other securities, whether held individually or through mutual funds and exchange traded funds, can decline significantly in response to adverse market conditions, company-specific events, changes in exchange rates, and domestic, international, economic, and political developments.
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103696 | C22-18512 | 02/2022 | EXP 02/29/2024