Jonathan Dash is the founder of Dash Investments. As CIO, he is responsible for the company's investment management and asset allocation decisions.
Even if expected at some point, this market sell-off is still relevant. A rare wave of rising inflation, extreme stock market volatility, falling bond prices, and an escalation of geopolitical conflicts have pushed investors to the brink.
As unusual as the current climate may be, it is important to remember that we have been here before. Lessons from previous market sales have taught us that it would be a big mistake to give up and walk away. While this can improve investor sentiment in the short term, it can be disastrous for their long term investment results.
It can be difficult to see your portfolio shrink by 20%. However, maintaining a historical perspective can sometimes reduce pain. In 1928, the market correction of the S&P 500 averaged 10% or more every 19 months. It is about once a year. Larger dips rarely occur when the time horizon extends beyond the last callback.
Although the specific reasons for each sale in the market differ, the attractiveness of the market is part of the stock market's DNA. Here is a historical breakdown of the frequency and duration of increasingly severe market withdrawals:
The biggest drops, over 30%, are much rarer, but we have had two since the turn of the millennium.
The most important lesson from this story, in my view, is that after every market downturn since 1928, stronger and more stable market growth has pushed stock prices to new levels.
The human instinct is to do something, anything, when fear is felt.
The thing is, you can't blame investors for wanting to rush during the volatile market declines. This is a perfectly rational answer. People tend to act when they feel pain – they instinctively think they need to do something to relieve the pain and feel better. What is not wise is to sit back and face the big circles of the market, especially when you see that the value of your portfolio is gradually decreasing.
But this is for investors who only know stock prices, who watch the daily ticks and clear their accounts when they see their prices plummet. It's a terrible feeling that can push many people to action, even if it means selling deep or constantly selling in the market.
Remember that the stock involves a permanent loss of capital, which will take years to recover. Investors fear the pain of loss far more than the benefit of profits. They feel better about keeping their money on a certificate of deposit (CD), even if it loses value every day as inflation consumes their money. More importantly, inflation-driven negative returns from CD or other monetary investments cannot create a life of adequate income. Investors who overweight cash to avoid market volatility are more likely to have cash in retirement.
For a reliable retirement, investors need to accept volatility
In today's environment of low yields and falling bond prices, investors looking to secure their financial future need to invest in assets that generate sufficient returns to grow their holdings. The problem for many is that investing in anything other than cash means tolerating instability.
I've written in the past about why investors shouldn't be afraid of volatility because it has worked in their favor over time. Since the inception of the stock market, volatility has been the key to long-term positive returns over time. Instability isn't your biggest risk; Your biggest risk is how you react to it.
But if market exit is a rational response to falling stock prices, how should investors stay afloat? Remember I said this was a rational answer for investors who only know stock prices. When you often pay attention to stock prices or your bank statements, it limits you to the short term, making it difficult to understand what's going on right now. While selling stocks in the midst of a recession may seem intuitive, it also prevents you from bouncing back when the market recovers.
A well thought-out financial plan will help you do this.
Conversely, investors who are aware of the historical outlook and their financial plan have far less difficulty staying on track. Having a solid financial plan helps investors overcome turbulent times in the markets.
A well thought-out financial plan affects worst-case scenarios for inflation and the stock market. Therefore, instead of predicting a historical return of between 8% and 10%, it is possible to predict a return of 5%. It must also take into account above-average inflation rates. A good financial plan is created to exceed goals while being extremely cautious with assumptions.
For our business, we also make our clients' financial plans more flexible with enough money to cover living expenses for two years. This is so they don't have to sell stocks when the market goes down, which usually leads to faster exhaustion of assets. Bear markets average around 289 days, so a two-year buffer is enough to allow the market to finish and possibly start a recovery phase.
Worst-case planning with low assumptions and sufficient liquidity buffers gives investors the confidence that they can handle high volatility and sustained declines and the confidence that they will stay on course.
The information presented here does not constitute investment, tax or financial advice. You should contact a licensed professional for advice on your specific situation.
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