As stock market volatility continues into the second half of the year, many investors are growing increasingly concerned about their investment portfolios. Many have already fled the market for the perceived safety of cash. Yet market-timing is often more costly than sticking to your investment plan in turbulent times.
Indeed, long-term investors benefit from equities because of the higher returns they generate over time. This growth is necessary to outpace inflation, so that your dollars maintain their value well into the future. However, growth comes at a cost. Meaning, investors must endure periods of discomfort to successfully achieve their goals.
Naturally, staying the course may be easier said than done, especially as your account balances decline. At the same time, it’s important to remember that paper losses aren’t permanent—unless you decide to sell.
Before you let your emotions get the better of you, consider the potential costs of market-timing:
#1: The average investor consistently underperforms the broad market due to poorly timed trades.
Successful investors aim to buy low and sell high. Yet research shows that in practice, the average investor does just the opposite. Dalbar’s annual Quantitative Analysis of Investor Behavior report repeatedly shows that across time horizons, investors tend to consistently underperform broad market benchmarks by wide margins.
For example, the average equity investor earned an annualized return of 7.13% over the last 30 years through 2021. Meanwhile, the S&P 500 Index generated an annualized return of 10.65% over the same period. That means the average investor underperformed the market by about 3.5% annually over 30 years. According to Dalbar, the disparity in results can largely be attributed to investors buying and selling at the wrong times.
#2: Market-timers are more likely to miss out on market rebounds.
When the S&P 500 dropped 34% from peak to trough at the beginning of the Covid-19 pandemic, many investors panicked. Fortunately, that bear market was surprisingly short-lived, lasting only 33 days.
The S&P 500 subsequently gained 75% over the next year. Investors who stayed the course were rewarded handily, while those who sold prematurely locked in their losses.
Research shows that while the duration and magnitude of bear markets vary, they tend to share one commonality: the recovery in the first year tends to be significant. Though no one can predict the future, there’s no reason to believe this time will be different.
#3: Deviating from your investment plan may keep you from reaching your financial goals.
No one likes market volatility. Nevertheless, when you expect it, you can plan for it. While your investments may lose value from time to time, a sound investment plan is designed to help you successfully reach your financial goals.
However, deviating from your investment plan can undo years of progress towards your financial goals. While the potential consequences of market-timing may feel abstract now, they can have a very real impact on your quality of life down the road.
How to Avoid Market-Timing in Turbulent Times
Keeping your emotions in check can be challenging—especially when it comes to your money. The good news is there are steps you can take to avoid the potential costs of market-timing.
First, be sure to set clear and realistic financial goals. Aiming too high can lead you to take on excess risk to close the gap between where you are now and where you want to be.
In addition, don’t let market activity be a reason to change your investment approach. Instead, focus on the things you can control—for example, your asset allocation, investment costs, and spending habits. Furthermore, make sure your investment portfolio is properly diversified. This may help smooth the ride over time as markets fluctuate.
Lastly, consider working with a fiduciary financial advisor like Sherwood Wealth Management who can help you develop a long-term investment plan that’s aligned with your risk tolerance and goals. We can also help you stay the course when your emotions begin to get the better of you. To get started, schedule an introductory phone call.