During a volatile market environment like we find ourselves in today, or the steep market pullback at the onset of the pandemic in 2020, we know many investors feel a powerful drive to take some kind of action in response. Most commonly when markets are down sharply the action desired is to sell stocks as a way to reduce risk. While taking action creates a sense of control that can make people feel better in the moment, most often in these situations it’s exactly the wrong thing to do at that time. Our Chief Investment Officer, Jeremy DeGroot said it well in an investment commentary:
As a long-term investor, trying to time market tops and bottoms is a fool’s errand. The evidence is overwhelming that most investors diminish their long-term returns trying to do so. They are more likely to chase the market up and down, and get whipsawed, buying high and selling low.
As we wrote back in 2020, market timing, while tempting, involves getting two nearly impossible decisions right: when to sell and when to get back in. Below is some updated information about the impact of making reactionary investment decisions.
This table shows the 15 best days for the S&P 500. Surprisingly, all of them occurred within bear markets, not bull markets as you might expect. That is, the big upturns in the stock market can happen during times when it’s hardest to remain invested or tempting to get out of the market and wait for better days. Looking at these dates, you’ll find the who’s who of dark times for the stock market: the 2008 financial crisis, the dot-com crash, the Black Monday crash of 1987, and the pandemic-driven market decline in 2020.
By trying to miss the worst days, investors are very likely to miss the best days. In studies of behavioral finance, “recency bias” suggests that someone’s most recent experience has the greatest influence on their decisions. As such, investors tend to sell after a meaningful market selloff and buy after a market rally.
Missing just the 10 best days (out of more than 17,500 trading days since 1950) has a huge long-term effect on a portfolio. For example, an investor who invested $10,000 in the S&P 500 in 1950 would have gained 7.9% annualized and finished with a portfolio value of more than $2.38 million (as of 5/10/2022) if they had remained fully invested (not including dividends). The final portfolio value for an investor that missed the 10 best days is well below half that amount at roughly $1.07 million.
Now it is unlikely an investor will only miss the best days if they sell in an attempt to time the market. They might also be able to miss some of the historically bad days. However, the cautionary tale of attempting to time the market is the same: There can be a huge cost to pay if the market swings to the upside while you’re on the sidelines. It would take exceptional timing skills to get in and out of the market perfectly, particularly since it needs to be done in short order given the market’s best and worst days tend to cluster close to one another. Staying the course is the best plan of action during periods of severe market stress. There is an old investing adage: “Time in the market beats timing the market.”
Owning stocks on historically bad days can be unsettling, but outcomes over the next year tend to be favorable. Investment industry giant BlackRock recently published a table showing one-year returns following the worst days for the S&P 500. The average one-year return after a historically bad day has been 30.3%. And there has only been one instance of a negative return.
This period of global unrest and economic uncertainty is still unfolding, and the drive to act can be difficult to resist. .In our role as wealth advisor to our clients, we take seriously our responsibility to help guide thoughtful decision making and wise action. Today more than ever, we want to focus on what we can control and not let ourselves be distracted by things we can’t. In discussions with clients we have found there are a number of positive steps that we can take together during this time. Below are several of the more common actions we are recommending:
If you would like to review any of these or other actions that could benefit your situation, please do not hesitate to reach out to your Litman Gregory advisor for a more thorough and personal discussion.
—Litman Gregory Investment Team (5/12/22)
Chris Wheaton & Gretchen Hollstein Named as 2022 Forbes Best-in-State Wealth Advisors
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Insight Newsletter—First Quarter 2022
This quarter's client newsletter includes our investment commentary, an update on our firm's investment strategy, the latest Litman Gregory Wealth Management news, and more.