It’s normal to feel anxious, concerned, worried, or even fearful during times when markets are highly volatile or losing value. It’s also understandable if this volatility or decline makes you feel like it’s time to get out of the market.
There’s a reason for this: research shows that, as humans, we feel the pain of loss much more sharply than we feel the joy of winning, gaining, or earning.
This is called “loss aversion,” and it’s the reason you might feel extremely passionate about doing something like getting out of the market and moving your portfolio cash.
That nagging voice that is probably getting louder and louder with each passing day that you need to get out now is the part of our brain that hates the feeling of losing anything.
Loss aversion is a byproduct of evolution; it’s our brains trying to keep us safe. This made sense tens of thousands of years ago. It makes less sense in the modern world and almost no sense at all when it comes to finances.
(And our brains do all kinds of weird things when money gets involved.)
Here’s what you need to understand: during a market downturn, your emotions actively try to convince you to do irrational things that go against the strategic investment plan you laid down when things were less emotionally charged.
Here’s an example from the most recent time we went through a market upheaval like the one we’re seeing now to illustrate how this can hurt you.
Panic Leads To More Losses Than Volatility
Vanguard created a chart to show what happened to 3 investors who found themselves at the bottom of one of the worst bear markets in history: the Great Recession.
From 2008 to 2009, even balanced portfolios lost almost 30% of value. It was, to say the least, a stressful time to have money in the market.
Each of the investors chose a different course of action:
VANGUARDSo how did the investors end up?
What this shows us is that the investors who panicked and sold equities at the bottom of the market would have taken years to break even… or they would have realized their losses and locked them in, to wind up with far less money than they would have had they done nothing and simply stayed the course.
If You Get Out, When Do You Know You Can (And Will) Get Back In?
Even getting out of the market “just until the worst is over” is a dangerous move for long-term investors.
First, market timing in general is a loser’s game. It’s nearly impossible to predict when to jump out so you miss all the worst days without missing the good days, too.
Second, missing even a few of those very good days could make a huge impact on long-term returns.
Check out this other chart from Vanguard. It shows the average return of the S&P 500 between 2000 and 2017. If you’ll remember, the S&P 500 had some really bad days during these decades.
But if you stick to your plan and stay invested for the long term and experience all the days in the market, including the nasty ones, you still show a decent return over this period:
VANGUARDBut if you miss just 10 of the best days over almost 20 years? You cut that return almost to nothing.
And when you miss the best 25 days over those decades? You actually lost money.
As Vanguard put it, “Missing the best market days would be a good way to destroy your long-term outlook.” Not exactly the goal you’re going for here.
Don’t Realize The Risk, Then Miss Out On The Rewards Of Recovery
Still, even if you know this, it can be hard to sit on the sidelines when it looks like everything in the market is going to hell. Market declines are not fun to experience and when you’re going through it, it can feel like recovery from the worst just isn’t possible.
Historically, though, we can see that markets do recover.
Even after steep declines, equities have generally delivered strong returns one, three, and five years after a downturn, as shown in this chart from Dimensional Fund Advisors:
DIMENSIONAL FUND ADVISORSAs DFA points out, if you’re invested when a market downturn begins or market volatility kicks up, then you’ve already experienced the risk of being an investor.
If you jump out now, you have no opportunity to get the reward of a future return.
Your Investment Experience Will Likely Improve If You Play the Long Game
The other thing we know? That markets are cyclical.
Check out the chart Ben Carlson put together on this post from A Wealth of Common Sense. Ben Carlson looked at every month since 1926 that experienced losses in the 8-9% range… and then looked at the market returns 1, 3 and 5 years after those dips.
Stocks were higher 59% of the time 1 year after experiencing that 8-9% loss. They were higher 82% of the time 3 and 5 years after, too.
What this reinforces is that you will improve your investment experience if you treat it like a long-term game.
“Long-term” might mean we have 10, 20 or 30+ years to go. Things might continue to get scary before we're back to clear skies and sunshine again (and in fact, to be frank, we do expect things to get worse before they get better).
Experienced long-term investors know to expect this.
Volatility, corrections, and even downturns or recessions are all normal parts of the investment experience, and if you understand that now, you may find it easier to grin and bear it through these tough times.
It’s Okay To Feel Worried Or Concerned — The Problem Is The Reaction To The Emotions
It’s been a strange end to quarter 1 of 2020 in the financial markets, to say the least. Long story short, increasing panic about coronavirus caused serious volatility in the market.
I completely understand if you’re feeling uncertain, worried, or even fearful. There is nothing wrong with those emotions.
But during times like these, it’s critical that we keep perspective, stay rational, and ground ourselves in reality (rather than getting wrapped up in the sensationalism of headlines and talking heads on TV).
This is not to minimize the potential risks of a contagious illness. This is not to say stick your head in the sand and ignore the world around you.
Feeling concerned about what’s going on is normal and not a problem. What can pose a problem is acting on those emotions and deviating from the set course of action you have in place as part of your long-term plan.
Reacting emotionally right now could lead you to doing something irrational (and detrimental) to your long-term financial health and goals. And we set plans and strategies for a reason: so that we have something to ground ourselves with in times of uncertainty.
Throwing your plan out the window right now because you're scared is like taking your life vest and flinging it as far from you as possible because you're worried about the ship sinking.
That would be silly and self-defeating, to say the least. So don't throw your carefully-designed financial plan away when you need it most.
Current market volatility is not fun to ride out. But if you're investing for the long-term, don't get pulled off track by the distractions of right now.
Continue looking at the forest that is your entire time horizon of many decades rather than pressing your nose up against the tree of today and failing to see anything else but what’s right in front of you.
The money in your investment portfolio isn’t there because you need it tomorrow; it’s there because it’s working to build the wealth you need for years down the road.
