You’re feeling like a grown up – with a savings account, a checking account and you’ve even started investing. But all of a sudden the market seems to be going south, and you’re getting nervous about whether you’ve made the right financial planning decisions. Today, guest blogger Nichole Coyle, Certified Financial Planner™, talks about what to keep in mind during a market decline, and how to keep your cool.
1. Market declines are part of investing.
Although stocks have risen steadily for most of the last decade, history tells us that market declines are an inevitable part of investing. The good news is that corrections (defined as a decline of 10% or more), bear markets (an extended decline of 20% or more) and other challenging patches haven’t lasted forever.
The Standard & Poor’s 500 Composite Index has typically dipped at least 10% about once a year, and 20% or more about every six years, according to data from 1950 to 2019, according to American Funds. While past results are not predictive of the future, each downturn has been followed by a recovery and a new market high.
2. Time in the market matters, not market timing.
No one can accurately predict short-term market moves, and investors who sit on the sidelines risk losing out on periods of meaningful price appreciation that follow downturns. Every S&P 500 decline of 15% or more, from 1929 through 2019, has been followed by a recovery. The average return in the first year after each of these declines was 54% according to American Funds.
Even missing out on just a few trading days can take a toll. A hypothetical investment of $1,000 in the S&P 500 made in 2010 would have grown to more than $2,800 by the end of 2019. But if an investor missed just the 10 best trading days during that period, he or she would have ended up with 33% less.
3. Emotional investing can be hazardous.
Emotional reactions to a market decline is perfectly normal. Investors should expect to feel nervous when there is a market decline, but it’s the actions taken during such periods that can mean the difference between investment success and shortfall.
4. It’s best to stick to a plan.
Creating and adhering to a thoughtfully constructed investment plan should be a smart way to avoid making short-sighted investment decisions — particularly when markets move lower. The plan should take into account a number of factors, including risk tolerance and short- and long-term goals.
One way to potentially avoid futile attempts to time the market is with dollar cost averaging, where a fixed amount of money is invested at regular intervals, regardless of market ups and downs. This approach creates a strategy where more shares are purchased at lower prices and fewer shares are purchased at higher prices.
Over time investors may pay less, on average, per share. Regular investing does not ensure a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining. Retirement plans, where investors make automatic contributions with every paycheck, are a prime example of dollar cost averaging.
5. Diversification matters.
A diversified portfolio doesn’t guarantee profits or provide assurances that investments won’t decrease in value. However, it can help lower those risks. By spreading investments across a variety of asset classes, investors can buffer the effects of volatility on their portfolios. Overall returns won’t reach the highest highs of any single investment — but they won’t hit the lowest lows either. For investors who want to avoid some of the stress of downturns, diversification can help lower volatility.
6. Fixed income can help bring balance.
Stocks are important building blocks of a diversified portfolio, but bonds can provide an essential counterbalance. That’s because bonds typically have low correlation to the stock market, meaning that they tend to zig when the stock market zags.
Bonds can potentially help soften the impact of stock market losses on your overall portfolio. Funds providing this diversification can help create durable portfolios. Investors should seek bond funds with strong track records of positive returns through a variety of markets.
Though bonds may not be able to match the growth potential of stocks, they have often shown resilience in past equity declines. For example, U.S. core bonds were flat or positive in five of the last six corrections.
7. The market tends to reward long-term investors.
Is it reasonable to expect 30% returns every year? Of course not. And if stocks have moved lower in recent weeks, you shouldn’t expect that to be the start of a long-term trend either. Behavioral economics has shown that recent events often carry an outsized influence on perceptions and decisions. It’s always important to maintain a long-term perspective, but especially when markets are declining. Although stocks rise and fall in the short term, they’ve tended to reward investors over longer periods of time. Even including downturns, the S&P 500’s average annual return over all 10-year periods from 1937 to 2019 was 10.47% according to American Funds. It’s natural for emotions to bubble up during periods of volatility. Those investors who can tune out the news and focus on their long-term goals are better positioned to plot out a wise investment strategy.
As always, if you have questions or would like to discuss your unique situation or more money saving tips, please don’t hesitate to contact me.
Nichole M. Coyle
CERTIFIED FINANCIAL PLANNER™
20333 Emerald Pkwy
Cleveland, OH 44135
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All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Investors cannot invest directly in indexes. The performance of any index is not indicative of any investment. It does not take into account the effects of inflation and the fees and expenses associated with investing. Dollar cost averaging will not guarantee a profit or protect you from loss. Dollar cost averaging may reduce your average cost per share in a fluctuating market. A diversified portfolio does not assure a profit or protect against loss in a declining market.
Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. The S&P 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses. Fund prospectuses can be obtained from a financial professional and should be read carefully before investing.
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