The vast majority of investors do not even want to consider what a 10% drop in the market would do to their portfolios, let alone talk about what they’ll do when it happens.
But it’s going to happen. We just don’t know when. Are you prepared?
According to a study of the behavior of the S&P 500 index over the past century, a drop of at least 10% occurs on average once a year. By comparison that would be like the Dow Jones Industrial Average dropping roughly 2,500 points from recent levels.
Yet even though it’s statistically very likely that the market will experience this kind of downward volatility even in economically healthy times, when it does happen many investors react as if the unthinkable has just taken place. You’ll hear the word “Correction” repeated from all sorts of financial media as if recent prices are somehow incorrect. These are the times when people who are saving for their retirement often react, causing serious damage to their nest egg.
When That Terrible Low Was Last Year’s Record High
Remember, there’s no free lunch. Risk and return are related. Downturns in the market are simply a part of investing. With individual stocks moving in a mathematically random manner, it’s impossible to predict which direction even one of them will go on any given day—let alone the market as a whole.
But there is a way to prepare yourself for the inevitable drop in stock market averages in a way that takes away some of the sting of a short-term decline in portfolio value. Instead of focusing on the short-term movements, maintain a long-term perspective.
It’s that simple!
A 1/10th drop in the market this week would return us to the record high of about a year ago. At the time of this writing, the S&P 500 reached recent new highs of over 2,500 points. A “disastrous” 10% so-called correction would take it down to about 2,250 points, the record high reached in late October 2016. The same number that might tempt some investors today to wonder if they should be in the market at all was a cause for celebration about a year ago.
There’s nothing pleasant about a market decline that large. You can be sure it will be accompanied by plenty of scary headlines.
But if you as an investor can resist the urge to act on emotion (and change your investments at the worst possible time), you have a much greater opportunity to make a full recovery.
The study cited above found that, on average, the market as measured by the S&P 500 index took 115 days to recover from a 10% decline. However, cashing out at or near the bottom, makes your temporary paper loss permanent.
The Discipline Dividend
Because of the random nature of the market, rapid declines often come without warning. Having the discipline to remain committed to your investing strategy is the most reliable way to reap its long-term outcomes.
Of course, there will always be market predictions about what’s going to happen next but nobody actually knows with any degree of certainty. And when a market drop comes, somebody somewhere will have been the most recent person predicting the drop. Don’t be surprised (or fooled) when the financial media presents them as someone with extraordinary insight or skill.
Hindsight often tempts us to think “I knew it” or “I had a feeling” after the fact. This emotion makes it even more difficult to sit pat and not react in some way. Sadly, giving in to this urge to “do something” is what keeps many investors from reaching their investment potential compared to the major indexes. That’s why preparing yourself mentally and emotionally in advance is part of maintaining a prudent investment strategy.
After your trusted advisor (hopefully that is our firm) has worked with you to create a long-term investing plan, the most valuable service they can offer you is the encouragement to stay the course. If you find yourself with doubts or questions, be sure to reach out for a conversation about what makes the most sense to do or NOT do for the long term.