We’ve all heard the old adage to “buy low, sell high,” but the reality is, some investors do just the opposite—they buy high and sell low. Taking a look back at market history, while factoring in behavioral science, shows us not only why investors react this way, but more importantly, how they can avoid it. If we have a better understanding of market volatility, the risks of certain investment strategies, and the value of a thoughtful investment plan (that you can stick to), we can invest with confidence and stay on track in pursuit of our goals.
Investing with confidence: Money means emotion
Investing with confidence: A brief history lesson on the markets
Investing with confidence: Keep your view on the horizon
So, what’s the big deal if we follow the herd and sell when prices are going down, especially if it makes us feel better? We can always buy back in, right? This is what’s known as trying to “time the markets.” You sell before it declines more and buy just before it goes back up too high. While this may sound tempting, it could end up costing you money. Timing the market incorrectly can set you back significantly. If you sell when the market’s declining, you have to figure out exactly when to reenter. If you do this at the wrong time, you “lock in your loss.”
This happens because you don’t know in advance what the bottom will be. By the time you figure it out, you’re selling close to the lowest point. When you do decide to buy back in, after seeing if the market is truly starting to move upwards once again, prices have already increased.
To explain what this means, let’s imagine a scenario. Let’s say you invest $10 and the market declines, making your investment worth $5. You sell out. Now you have $5 instead of $10. A few weeks later, that same stock goes back up to $12. But because you sold out, you didn’t benefit from that increase. You’re stuck with a $5 loss.
It could continue to increase, but you have a challenge. Before you can make money again, you need it to go up to $19 to make up for the $7 you lost. Then you need it to go up even higher so you can actually make money off your investment. That’s a steep hill to climb. If you’d just stayed invested, you’d have made $2 instead of losing $7.
This is a simplified hypothetical example of an investing concept and is not representative of any specific investment. Your results may vary.
Once again, history tells an interesting story. The investing herd has followed our example above and attempted to time the markets, potentially losing out on 4.6% in returns over 20 years like the average investor.1 The other problem with timing the markets is that the best days— when you could potentially make the most money—tend to occur right next to the worst days.2
There’s no way to know exactly when the market is going to go back up again. Something could even happen after market close one day that causes the markets to increase the next—before you have a chance to buy back in if you’ve sold out. In fact, if you started investing in 1990 and missed the S&P 500’s best day of the year each year, your annual return would be reduced by almost 4%.
The annualized gain for the S&P 500 from 1990 to 2021 was 9.9%. Yet, if you missed only the best day of each year, that return dropped to 6.1%, a difference of 3.8%. Miss the best two days of each year, and you would be up less than 3% a year. Taking it to the extreme, if you missed the best 20 days of each year, you’d be down 24.4% per year.3
No one can consistently pick the best or worst days of the year, which is why it can be so dangerous to attempt timing the market. If you miss one or two big days, compounded over time, this can greatly impact your portfolio.
By going against the flow and staying invested in your long-term plan, you could potentially end up with returns—like the S&P 500 Index return of 9.96% since 19904—that can help you work toward your future goals.
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1. Source: LPL Research, Bloomberg, DALBAR, ClearBridge Investments 06/30/21
2. Source: Calamos Investments, Market Volatility April 2022. Performance data quoted represents past performance, which is no guarantee of future results. The S&P 500 Index is generally considered representative of the U.S. stock market.
3. Source: LPL Research, FactSet 04/29/22. All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. S&P 500 Index performance before 1957 is based on its predecessor index, the S&P 90.
4. Source: Dalbar Inc., “Quantitative Analysis of Investor Behavior,” March 2020.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
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