S&P 500, the benchmark for U.S. equities fell to as low as 2,585.89 on friday, putting it within reach of its 200-day moving average. It plunged 6 percent over last five days, erasing its gains made in 2018 and declining 3.2% for the year, as concerns mounted on higher interest rates and a brewing trade war puting a break on global growth. I have been hearing increasing chatter from friends on the need to wait out the global uncertainty and reduce any further exposure to the stock markets.
In 2017 the benchmark S&P 500 was up every month and volatility was lowest on record since mid-1990’s. Such a positive market environment with minimal volatility and month on month growth can change the perception of risk for investors due to “recency bias” – tendency to think that recent events are the new normal and will continue. The markets recent 10% decline is a reminder that markets and volatility go hand in hand and many investors are stunned to see how quickly things can change and adversely impact their portfolio and quality of sleep. This is when emotions take over and hasty decisions are made.
Over the last 91 years, the S&P 500 went up 66 years and went down 25 years, or in other works the markets delivered a negative return once in every four years. Markets have to correct before they make further highs. The worst market return was –43.84% in 1931 and the best return was 52.56 % in 1954.
So what should I do in volatile markets?
Inaction is the best action! Downturns are normal and usually short lived.
Market downturns can cause anxiety even to a seasoned investor, but history has shown that US shock markets have been able to recover from declines and have trended upwards in the long term. According to research from Fidelity, over the past 35 years the market has experienced an average drop of 14% from high to low during each calendar year, but still had a positive annual return more than 80% of the time – see chart below.
As Warren Buffett has said, “the stock market is a device for transferring money from the impatient to the patient.” So, keep calm, do not turn your notional loss into real loss by hasty decisions.
Do not try to time the market
Attempting to move in and out of the market can be injurious to your financial health. According to multiple studies, decisions investors make about when to buy and sell funds cause investors to perform worse than a simple buy and hold strategy. It is impossible to consistently predict the highs and lows and hence attempting to do this will be foolish and have long term consequences. One research datapoint that is cited frequently is that – missing just the 10 best days in the market (as represented by the S&P 500 Index) over the past 25 calendar years (1992–2016) would have reduced returns by more than 50%. (Missing the 20 best days was even worse, reducing returns by 69%, while being absent for the 30 best days would have cost a staggering 79%.)
Amid a correction, you may find yourself becoming emotional and wanting to sell because you’re anxious and wanting to avoid the possibility of more pain. This approach is flawed based on Peter Lynch’s research indicating – far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.
Invest regularly, despite volatility
If you invest regularly over months, years and decades, short term downturns will not have impact on your funds returns. Take a disciplined approach of making investments weekly, monthly and you will not have to worry about market volatility and timings. When the prices drop, you will buy a larger quantity of shares, thereby lowering your average cost of acquisition. In fact, what seemed like some of the worst times to get into the market turned out to be the best times.
The best 5-year return in the U.S. stock market began in May 1932—in the midst of the Great Depression. The next best 5-year period began in July 1982, amid an economy in the midst of one of the worst recessions in the postwar period, featuring double-digit levels of unemployment and interest rates.
For more stories on personal finance read – Decoding the new tax code. Will you pay lower taxes?
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