Don’t trust your gut, at least when it comes to falling — or surging — stock prices.
Your natural response to a massive sell-off or a big gain in stocks may be to “do something,” especially since so much of your wealth, and ability to comfortably retire, may be tied to the returns of various investments, including stocks.
And it’s easy to focus on the volatility.
On Dec. 19, 2018, the Federal Open Market Committee voted to raise the target range for the federal funds rate 25 basis points – during a multiple-day decline for the Dow Jones industrial average.
Then on Dec. 26, 2018, the Dow surged more than 1,000 points – its largest increase in a day. Ever.
Finally, on Jan. 4, Fed Chair Jerome Powell spoke at the American Economic Association and Allied Social Science Association 2019 Annual Meeting and reassured markets that the Fed’s policy is flexible and that he won’t resign if Trump asked him to – sending the Dow up more than 600 points.
These few weeks of events sent the market pretty much back to where it was at on Dec. 19, 2018.
The lesson is clear: one day, one week or even one month doesn’t usually shape the long-term market.
Responding to market volatility by selling stocks is hardly ever a good idea. Here’s why.
Investors too often act when they shouldn’t
Investors have this nasty habit of buying high and selling low.
For instance, the Dow Jones industrial average (DJIA) sunk to 21,792.20 on Christmas Eve. Two days later, the Dow climbed more than 1,000 points. If selling on Christmas Eve was your gut instinct, that probably was the wrong move.
Another example is when the S&P 500 closed 2008 at 903.25. That index ended 2018 at 2,506.85 – which results in a 10-year annualized return of more than 10 percent, according to S&P Dow Jones Indices. If you didn’t get back in at the right time – and sold prior to 2008 – you missed out on seeing the market reach uncharted territory.
Basically, investors get psyched out by news and make bad bets on what that bit of news means for stock prices.
Losing is painful, but not investing is even more so
Reacting to market ups-and-downs belies what financial planners tell you to do. Stock prices will rise and fall, but they’ll mostly gain over the long haul. The only way to profit off long-term returns is to keep your money working for you, even when the sky looks like it’s falling.
Part of the problem, according to William Bernstein of Efficient Frontier Advisors, is that many investors overestimate how much of a loss they’re willing to endure.
He has an illustrative graphic in his book, “Rational Expectations,” that shows people are more apt to trash their carefully crafted financial plan as losses mount. It just doesn’t feel good to see the value of your accounts get smaller.
What to do when the going gets tough
The easiest answer, then, is not to do anything. Well, maybe turn off the television, silence your phone and go for a walk.
Presumably you’ve allocated a certain percentage of your assets into stocks for a reason, and that reason shouldn’t change because of a series of short-term drops. Talk to investors who sold at the market bottom in March 2009 and missed out on the subsequent recovery. Equities are riskier than bonds, which are riskier than money market accounts, so you should expect bad things to happen every now and then.
Doing nothing, though, is hard. We’re human, and humans get nervous when green numbers turn into red ones. It might be unrealistic for you to expect yourself to do nothing.
If you’re the type of investor with an itchy trigger finger, you may have more risk in your portfolio than you’re comfortable holding. Consider shifting into an all-in-one balance fund — perhaps one that holds a mix of stocks, bonds and some cash. Though every investment in the market has risk, these target-date funds may help you diversify your portfolio and keep you from buying and selling too often.