Close your eyes for a moment and imagine this scenario.
You’re sitting in a comfortable chair on a sunny day, looking out at a beautiful vista with blue skies that go on forever. Then suddenly, near the horizon, you see storm clouds gathering. Eventually, they blot out the sun, darkening the sky, and bringing with them the sound of thunder. Next thing you know, you’re caught in a downpour.
What do you do?
For most of us, the answer is simple: we go inside. At the very least, we’d grab an umbrella or put on a raincoat as our human instinct is to try and do something, anything, to avoid getting wet.
That same human instinct also surfaces in times of economic or market volatility. Watching the drawdowns and losses – even if they are just on paper – in our 401ks and retirement accounts during an uncertain market is uncomfortable and we often feel like we should do something, anything, to avoid them.
For many investors, that “something” is timing the market, trying to determine when to pull money out of stocks. But is that the right move?
Are you investing for today or for tomorrow?
We know that the economy has a major influence on financial markets, and we know that the economy is subject to up and down cycles – which can include bear markets and recessions. But as scary as they sound, bear markets and recessions are a normal and regular occurrence.
Since 1929, there have been 27 bear markets in the S&P 500 and, on average, they occur roughly once every 3.6 years. However, they’re generally short-lived, usually lasting 9.6 months on average, though the last complete one we had in 2020 lasted only 33 days. The bottom line is, over a 50-year investment horizon, you can expect to experience roughly 14 bear markets.
You can also expect to encounter a recession or two. Since World War II, there have been 12 recessions and they have lasted on average a little over 11 months each.
So, what’s an investment strategy to help you reach your financial goals no matter what economic conditions we face in the future?
Stay invested, even during volatile times.
Ask yourself this, when you made your decision to invest, was it your intention to re-evaluate the market every time volatility spiked? That’s called market timing and it’s next to impossible to do.
Not only do you have to predict when to get out of the market, but you also must determine when it’s time to get back in. Trying to time the markets is not only exhausting, but ironically, you can increase your chances of underperformance. That’s because some of the biggest one-day rallies have occurred when expectations suddenly have changed during bear markets.
In fact, if you had been invested in the S&P 500 all 3,775 days the stock market was open between 2007 and 2021, but missed just 18 of the best-performing days during that time, your average return would have gone from 8.4% to zero.
Make sure you’re prepared with a financial plan
But what happens when there is a conflict between volatility and your need for money, like an unexpected expense?
“It sounds academic that you never pull your money out of the market, but life happens,” says Sean Wintz, executive director financial planning. “That’s why you need assets outside of the market that you can use instead of selling your investments.”
This helps mitigate something called sequence of return risk, which is the risk of receiving lower, or even negative returns when taking withdrawals from your portfolio during a down market. That’s because the assets you sell at lower valuations won’t have a chance to benefit if the market recovers and can’t take advantage of long-term growth opportunities. And this can adversely affect your investment portfolio’s returns.
“The goal with my clients is to set expectations at the beginning and create a plan to build enough cash reserves so that they don’t have to touch their investment during volatile times,” says Wintz.
“Markets are always uncertain. But having a plan helps remove much of the worry about money. If the market moves down today, we can ask, ‘do you need your money?’ If the answer is ‘no,’ then they’re OK. And if the answer is ‘yes,’ they’re still OK because we can go to their cash reserves instead of selling assets at a less-than-optimal time.”
At Edelman Financial Engines we help our clients create long-term, goal-based financial plans based on an integrated approach to wealth management. These plans are designed to help you achieve your financial goals at each stage of your life and are built to help anticipate different types of markets, as well as the cyclical nature of the economy. If you’d like to learn how Edelman Financial Engines can help you secure your financial future, contact us today. We’re here to help.