2022 is off to a rocky start for investing with the S&P 500 index down over 20% at one point from its peak. Tech stocks have been hit particularly hard with the average NASDAQ stock down 50% from its high. With the consistent decline in the stock market this year, you may be asking yourself, should I sell my investments now before they go lower? Looking at past market declines to see how you would have fared trying to limit losses by selling can lead you to realize that this strategy is not the best course of action for your nest egg.
Can’t I sell when the market starts to fall, avoid some of the losses, and then get back in later when it all seems clear?
Human behaviors’ basic desire to avoid loss makes this one seem like it makes all the sense in the world. The problem is it is dead wrong. It is probably the single biggest contributor to investors’ failure to achieve returns anywhere near what the market returns in the same period. The reason is simple: it involves market timing, which no investor, institutional or otherwise, has been able to consistently get right.
Many investors sell once they see the market start to correct but where they invariably fail is almost always staying out of the market too long. Timing requires guessing right twice, first you have to guess when the market is going to fall (or continue to fall) and then you have to guess when the market is done falling and get back in. There are so many factors that affect the stock market, and the direction of the stock market in the short run, that it is almost impossible to accurately predict its next move, let alone predict accurately twice in a row. If you don’t predict accurately, your return could be greatly affected. For example, if you were fully invested in the S&P 500 from 2007 to 2022, you would have received an annual return of 10.66%. However, if you traded out of the S&P 500 and this resulted in you missing just the ten best days during the same period, your annualized returns would have dropped all the way down to 5.05%! Volatility works both ways and often the best days in the stock market follow the worst days. Being out of the market for any length of time, as you can see, can greatly reduce your return.
Remain in the Market for Long-term Success
The good news is you don’t have to guess when to be in or out of the market. All you have to do to be a successful stock investor, which we define as someone who receives market returns over time, is to diversify and not sell when the market is correcting or declining. The time period listed above included the great recession, the drawdown from the global pandemic in 2020, and the return for simply remaining invested was still over 10%. In fact if you look at stocks over any long-term time period, the return is always right around 10% annually. So as long as the money you have invested is for long-term investing, such as for retirement, you simply need to accept that you will have volatility along the way and remain invested so that you can realize your rate of return in the long run. As you get closer to retirement, if you decide you want to reduce your overall equity exposure permanently, do it when the market is doing well, not when it is selling off. You want to sell from a position of strength not a position of weakness.
Many need to invest a significant amount of their portfolio in stocks in order to grow their nest egg to one day achieve a comfortable retirement. That being said, volatility will always come with stock market investing. While long-term stock returns can help you grow your assets, you have to accept that volatility is normal and comes with this investment. This volatility is the price you pay for higher returns that the stock market gives you. A disciplined investor will maintain a long-term perspective and not focus on day-to-day market moves.
(This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial adviser, as well as your tax and/or legal advisers, regarding your personal circumstances before making investment decisions.)