Market fluctuations are an inherent aspect of investing and should be anticipated.
Market changes can sometimes be unsettling, but they are a normal part of the investing landscape.
Understanding why they happen, why it’s essential to stay the course, and how they can present great investing opportunities can help you navigate these periods with confidence.
Why Market Drops Are Normal
Market Cycles
The market naturally goes through cycles of expansion (bull markets) and contraction (bear markets).
These cycles are driven by various factors, including economic conditions, investor sentiment, and global events. Understanding that market drops are part of these cycles can help put them in perspective.
Events such as recessions, geopolitical tensions, and changes in interest rates can trigger market drops. These events are part of the broader economic environment and can cause temporary declines in market values.
Market Corrections
A market correction is commonly defined as a decrease of 10% or more in a major stock index. These corrections are a regular occurrence and typically short-term, acting as a natural adjustment for overvalued markets.
The chart below shows the yearly returns of the stock market since 1980 (bars) and each years market correction from the high (red dots).
Why Investors Should Stay the Course
- Historical Perspective: Historically, markets have always recovered from drops, often reaching new highs over time. Staying invested allows you to participate in the recovery and growth that typically follows a market drop.
- Long-Term Goals: Your investment strategy is designed to meet long-term financial goals such as retirement, education funding, or wealth building. Don't let short-term market fluctuations derail your long-term plans. Staying the course helps ensure you achieve these goals.
- Compounding Returns: Compounding returns are the earnings on your initial investment and on the reinvested earnings over time. By staying invested, you benefit from compounding returns, which can significantly grow your wealth over the long term.
- Avoid Emotional Decisions: Emotional reactions to market drops can lead to panic selling and poor decision-making. Selling during a market drop locks in losses and can prevent you from benefiting from subsequent recoveries.
As illustrated in the chart below, yearly corrections are often subtle and may go unnoticed or appear as minor blips on the radar over the long term.
Market Drops = Great Opportunities!
- You Get to Buy at Lower Prices: Market drops can present opportunities to buy quality investments at discounted prices. Purchasing assets at lower prices can enhance your long-term returns as the market recovers.
- Dollar-Cost Averaging: If you are using a dollar-cost averaging investment strategy (investing a fixed amount of money at regular intervals regardless of market conditions), this is your moment to shine! Market drops allow you to buy more shares when prices are lower, effectively reducing your average purchase cost.
- Rebalancing Your Portfolio: Market drops can be an ideal time to rebalance, selling over-performing assets and buying underperforming ones, ensuring your portfolio remains aligned with your goals.
- Tax-Loss Harvesting: Market drops can provide opportunities for tax-loss harvesting, which can improve your after-tax returns by selling investments at a loss to offset gains.
Why We Aren’t Market Timers
- Unpredictability of Markets: The market’s short-term movements are highly unpredictable and influenced by countless variables. Attempting to time the market often leads to buying high and selling low, which can erode your investment returns.
- Long-Term Focus: Our investment philosophy focuses on long-term growth rather than short-term gains. Staying invested over the long term allows you to benefit from the overall upward trend of the market despite short-term volatility.
- Historical Evidence: Historical data shows that the market recovers from drops and continues to grow over time. Missing just a few of the best days in the market can significantly impact your long-term returns, which is why we emphasize staying the course.
In the chart below, you'll see 75% of the stock market's best days occur during a bear market or during the first two months of a bull market. Using a $10k investment as an example, if you missed the market's 10 best days over the past 30 years, your returns would have been cut in half. Additionally, missing the best 30 days would have reduced your returns by 83%!
4. Consistent Strategy: A consistent investment strategy is more effective than trying to time market highs and lows. By maintaining a steady investment approach, you can reduce the risk of making poor decisions based on market timing and instead focus on your financial goals.
The best days tend to happen after the worst days.
At Advisor Wealth Management, we are here to help you stay focused on your financial goals and make the most of every market condition. For personalized advice and support, reach out to us at help@advisor.com.