Big market declines can be unnerving for investors, often triggering emotions of fear and concern, particularly if they occur unexpectedly or in a very brief period of time. However, such declines are historically not unusual. Market volatility fluctuates based on where we are in the business cycle and due to external events that heighten risk and threaten growth.
It is a normal feature of markets that investors should expect. When markets sell off, investment returns will head lower in ways that can leave investors with material losses. Does that mean you should try to sell when the market is “high” or sell if it starts to fall in order to reduce the potential for that kind of unpleasantness? Not necessarily. Here’s why:
Common Investing Mistakes
It’s extremely difficult to predict the timing of a market downturn with the accuracy needed to profit from such a prediction. In other words, it is easy to get such a prediction wrong, which can be costly. While we do tilt our portfolios more aggressively or more conservatively based on our market outlook, the data shows that individual investors who radically reposition out of stocks in an attempt to catch the tip of a market top reliably miss out on gains more than they prevent losses, and generate excessive transactions and tax costs along the way.
While “buy low, sell high” may sound like time-honored advice, the challenge of getting it right means it rarely is a good way to make decisions in practice. Indeed, individual investors who “sell high” and go to cash waiting for a market downturn to come and go, often lose patience as stocks continue to go up. This results in their missing out on gains rather than preventing losses. That costly mistake is the reciprocal of another, wherein panicking investors sell their holdings during a market selloff, potentially locking in losses as stocks rebound while they remain on the sidelines. The prevalence of these value destroying behaviors helps to explain why individual investors as a group tend to dramatically underperform market benchmarks.
There is a caveat to the generally superior buy-and-hold approach, which is that seeing a paper loss in your portfolio doesn’t feel good. Some investors would rather take less risk, which may mean giving up some long-term returns, in order to reduce the period of time they may need to wait out losses, making for smoother sailing.
Consider Your Goals
Another factor to consider is how you’re doing relative to your financial goals. That’s where a Financial Advisor can help by talking through goals and priorities and reassessing your portfolio based on where you stand. For instance, if you are saving toward a goal and have made good progress, it may make sense to take on less risk, regardless of the market outlook. This is for two reasons. First, it intuitively makes sense to take less risk when you have more to lose than to gain. Second, for additional peace of mind that your progress won’t be jeopardized, you may desire the lesser uncertainty that can come from a more conservative blend of stocks, bonds and cash.
If, like many of us, you have more progress to make and more road to travel towards achieving your goals, riding out the market’s jitters can be the best advice. Our research shows that markets are most predictable when you have a seven- to 10-year time horizon (due to how well current yields and valuations predict returns over those horizons). Our forecasts continue to suggest that stocks will outperform bonds and cash over that time horizon.
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Article initially appeared on morganstanley.com
Credit: morganstanley.com, NYSE, Nasdaq
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