posted on May 03, 2016 14:27
These news headlines probably sound familiar because similar stories are retrieved from the archives every time the market stumbles. Undisciplined investors may read these articles and make the rash decision that now is the time to jump ship. Have we mentioned that market timing is hard and it fails more times than not? Psychologically, market corrections are understandably painful for investors as they watch their account dwindle by 10%, 20%, and sometimes greater than 30%. However, evidence boasts that investors who maintain discipline and do not attempt to time the market usually reap a greater total return after the bull market bounces back.
Calculated with monthly figures dating back to 1926, the S&P 500 Total Return Index has undergone a correction of at least 20% eight times, leading to an average loss of more than 40% for investors. When the market falters, investors can be enticed to pull their money out of the market until the storm has passed and then reinvest when they know the coast is clear. When looking back, it is human nature to think, “What if I had pulled my money out of the market and re-invested at the bottom? My portfolio would have increased by 30%!” But hindsight is 20/20. There is a reason market timing is so difficult; some of these declines have spanned almost 1,200 days, while others have lasted a mere two months. Corrections are not limited to being 60 days or 1,200 days long; historical examples litter the timeframes in between. Each correction, bear market, and bull market is driven by its own unique factors.
An investor attempting to time the market based on the news or gut feelings is more likely to shoot themselves in the foot rather than hit their target. As painful as it may be, evidence shows that a disciplined, long-term investor usually benefits from sticking to their plan. Historically, once the market fell 20%, it had mixed results after one year. Beyond one year, however, markets typically had large gains as shown by the three- and five-year periods. It is no coincidence that the Great Depression marks the only period in which the three- and five- year performance was still in the red after the 20% drop. Stretching our study out to five years, the S&P 500 averaged a return of over 70% after the initial 20% decline. Evidence seems to imply that after a correction, returns can be eye-popping and certainly nothing an investor would willingly miss!
When investors focus on the short term, mistakes are made. While it can be agonizing watching the market drop with seemingly no end in sight, you must be present at all times to truly reap the rewards of investing. Remaining disciplined in treacherous markets remains a key step for investors looking to build their ideal future.