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If you try to avoid getting caught in a stock-market decline by selling your investments and keeping your money in cash until the worst is over, you are likely to lower the long-term performance of your portfolio. It is very difficult even for professional investors to get the timing right, and the tendency to buy back into the market well after its recovery has started makes all the difference.
You might be nodding along in agreement now — but maybe you know someone with less investing experience who could benefit from this lesson. There are always new investors, and perhaps some of them can avoid learning the hard way.
In the heat of the moment, when the stock market has taken a tremendous beating, emotions run wild and it is difficult to stay put and ride it out, even though the market has recovered from every previous crash. But if you can somehow discipline yourself not to sell into a declining market, you are likely to be rewarded.
There is more than one way to look at this behavioral phenomenon. Dalbar Inc., a research firm that focuses on the financial-services and healthcare industries, has compiled decades of data studying the effects of mutual-fund investors’ behavior. Here’s a summary of the data from Dalbar’s Quantatative Analysis of Investor Behavior, cited in the Prudent Speculator’s market commentary on Monday:
The Prudent Speculator is published by Kovitz Inc. and has the best 30-year record among investment newsletters tracked and audited by the Hulbert Financial Digest for 30 years through June 30.
According to the data, the detrimental effect of investors’ behavior has been magnified during the three- and five-year periods, even though the behavior has hurt them for all the periods shown. It is also interesting to see that investors in the bond market have have been hurt dramatically by market-timing behavior.
The above data doesn’t include fees. For example, the SPDR S&P 500 ETF Trust
SPY,
which tracks the S&P 500
SPX,
for a current annual fee of 0.09% of total assets, had an average annual return of 9.7% for 20 years through 2022, according to FactSet. That is close to the 9.8% average for the index in the chart.
This is from the Prudent Speculator’s commentary on Monday: “There is usually something about which to worry, yet equities have proved very rewarding through the years to those who remember that the secret to success in stocks is not to get scared of them.”
It has seemed for decades that we are always in the midst of some sort of financial crisis. There are warnings in the financial media about overvalued stocks every day in every market condition. When you watch a famous money manager raise the alarm in a television interview, keep in mind that he or she may not be moving to the sidelines. The money manager’s motivation to speak publicly may only be to maintain a high profile as part of an attempt to bring in more assets to manage, and thus to increase their fee income.
There is another another way that long-term data makes the same point about market timing. It turns out that stock-market recoveries tend to be lumpy. According to data compiled by JPMorgan Asset Management and cited in this this Forbes Advisor article, if you had invested $10,000 in the S&P 500 for 20 years through 2022, your account would have grown to $64,844. But if you had been sitting on the sidelines for the index’s 10 best days during that period, your account would have grown only to $29,708. So there went more than half of an investor’s growth in only 10 days. And the numbers go down from there as you miss more of the market’s best days.
Regardless of your long-term strategy, if you are an investor and not a day trader, history shows that commitment pays off. And that means taking emotions out of decision making. This is why a slow and steady approach, such as that used by investors who make automatic contributions from their paychecks into retirement accounts, can be such a powerful tool on the path to financial independence.
Don’t miss: Stocks in this left-behind sector are expected to rally as much as 33%
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