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January 2023 E-Newsletter: What Happens When You Jump Ship in a Volatile Market?

With many people concerned about market volatility, here is some food for thought. 

What Happens When You Jump Ship in a Volatile Market?

It can be terrifying when stocks turn volatile, leading many investors to make potentially costly mistakes, such as selling into a steep market decline. However, the biggest risk to investors is not a stock market decline, but how they react to them. Legendary investor Benjamin Graham said it best:

“The investor’s chief problem—and even his worst enemy—is likely to be himself.”

Benjamin Graham

To illustrate Graham's contention, consider a study by Dalbar comparing returns of the S&P 500 index with the average returns of investors. The 20-year annualized return of the S&P 500 was 7.43% through 2020, while the return of the average equity mutual fund investor during that period was just 5.96%. While that may seem like a small gap, a hypothetical investment of $100,000 invested in the S&P 500 would have grown to nearly $420,000 compared to $318,000 for the average investor. That's a difference of more than $100,000! Dalbar attributes that gap to emotionally based market timing decisions.1

The challenge for investors who attempt to avoid losses by selling in a market decline and then return when they think the market is recovering is they must be able to make two correct decisions each time, meaning when to sell and subsequently when to rebuy. Even more daunting, research by Nobel Laureate William Sharpe found that to outperform any index, you would need to make the right decision at least seven out of ten times—a feat very few investors can accomplish.

Volatility Cuts Both Ways

Investors who fear volatility also need to consider that negative volatility also occurs in rising markets during extended bull markets. These market corrections of 10% or more occur regularly, but they are often short-lived and result in market recoveries that send the markets to new record highs. If you abandoned the market during these periods, you are likely to miss out on some of the best returns in the market, permanently hurting your long-term investment performance.

Consider this graphic, which shows how your returns would have been impacted on a $10,000 investment if you missed the market's 5, 10, 30, and 50 best days. 

Source: Factset. Returns are based on the S&P 500 Total Return Index. Past performance is not indicative of future returns. An individual cannot invest directly in an index. Data is as of January 31, 2022.

The market experienced a real-life example of this during the 2020 pandemic-induced market crash. During the worst periods of that steep decline, two days had more than a 9% gain in the S&P 500. Both days were among the top ten return days in the market's history. The first occurred on March 13, just one day following the second-worst return day in twenty years. The second 9% burst occurred the day after the market crash bottomed on March 23. The market surged 40% from the March bottom in the months to follow.

If you abandoned the market in early March, as many investors did, and missed the five best return days when it rebounded 40% over the next six months, your portfolio would have lost nearly 30%. 

The point is that many of the market's best days occurred during the most volatile times in the market, which is why it's important to "stay the course" during these exact times. The "best days" do not happen when market volatility is low, and the market is moving up. They occur during volatile periods of market downturns. It's best not to pay attention to the financial news or check your portfolio daily during these times. You'll trick yourself into making a bad and very costly decision.

Tips for Dealing with Market Volatility

Riding out a volatile market is never easy. It doesn't help when investors frantically scour their accounts every day. History has shown that it's better to ride out periods of volatility and take advantage of upward stock market bursts it generates.

Here are some tips for keeping your calm while riding out severe volatility:

Keep it in Perspective

It's important to remember that market declines have always been a temporary interruption of its positive long-term trend throughout the stock market history. As the following graphic illustrates, short-term market declines appear as nothing more than blips on the market's long-term performance.  

Ignore the Media Noise

With its hyperbolic headlines and 24/7 news cycle, the media doesn't help. The media needs to sell advertising, and bad news sells better than good news. Pundits feed on fear to get ratings. However, much of the time, the information investors are getting is centered on driving viewership and not conveying optimal investment decisions. 

The media and punditry won't tell you that, while the news may be consequential at the moment, it has little if any impact on the long-term. While this month's investment returns or calamitous economic events may be consequential to our lives right now, their impact on our portfolio over a 20- or 30-year time frame is so minimal as to cause nothing more than a tiny blip on your long-term performance. (See the chart above)

Closing Thoughts

There has always been market volatility, which over the long term, has actually benefited investors. Without it, we wouldn’t see many of the big gains in the market. It’s essential to remember that, since its inception, the stock market has always rewarded patient and disciplined investors who adhere to a long-term strategy.

At Gardey Financial Advisors we help investors and their families navigate the market cycles through every economic season and answer any and all questions along the way.  If you find yourself in need of comprehensive wealth services, we invite you to take a tour of our website and learn more about our firm.  We best serve clients looking for exceptional client service, who value a long-term partnership, and have a minimum of $500,000 in investable assets.

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