The adage "buy low, sell high" is elegant in its simplicity, and yet, despite its pithy wisdom and seemingly infallible logic, history has shown that investors are not always capable of following this maxim—especially in market environments like the one we find ourselves in right now.
The US economy is in the late phase of its business cycle, with slowing growth and increased bouts of volatility. Recession fears are dominating the headlines. With so much downbeat economic and market news, it's no surprise that some investors may be fleeing the market for what they believe is safety or keeping their cash on the sidelines until it's clearer which way things may be headed.
Unfortunately, they may be undermining their long-term growth potential. Denise Chisholm, director of quantitative market strategy at Fidelity Investments offers a slightly tweaked version of the adage for the present moment. What investors may want to do, she says, is "buy uncertainty and sell certainty."
For investors who can look beyond what's going on in the news and stay focused on the long term, the down market could present an opportunity. While uncertainty, volatility, and recessions can be disruptive and disconcerting, when we look at historical trends, few economic events could be as damaging to the long-term growth of your portfolio than allowing fear to cloud your judgment.
The potential danger of reactive decision-making
Over the last 30 years, studies have shown that when investors have given up on their long-term strategies and begin reacting to short-term developments in the market, their portfolios have suffered.1 Reactive behavior on the part of an investor can be a significant drag on performance. For example, since 1992, the average equity fund investor has underperformed the S&P 500 index, largely due to investor attempts to time the market. In 2021, this gap was particularly wide: the average equity fund investor underperformed the S&P 500 by more than 10%.2
Part of the reason for this underperformance may be that investors might have an outsized impression of the impact that bear markets, volatility, and recessions may have on the long-term health of their portfolios. By making reactive or emotional decisions without the historical context, they may end up hurting their long-term growth prospects more than if they had simply ridden out the storm.
Putting the market environment into context
Consider the following reasons why an investor might be wary of investing in the current market environment:
1. I don't want to invest during a bear market because I'm worried about further declines.
It's entirely possible that we may see markets decline further. However, if you look back at previous bear markets, you'll see that staying out of the market could result in missing out on a potential recovery. Since 1950, stock market recoveries have often started soon after the bear market began, recovering a median of 8% during the rest of the same calendar year. Returns in the following years have historically shown even more promising results. Trying to time the market in an attempt to avoid losses or catch a rally is difficult or even impossible. It can often be a better idea to just get invested and stay focused on your long-term goals.
*Year occurred during a recession, as defined by the National Bureau of Economic Research (NBER), as of 6/30/2022.
2. I don't want to invest during the late part of the business cycle because I expect a recession to follow.
Being picky about when to enter the market based on where we believe the US economy is in the business cycle is unlikely to dramatically affect returns. When looking at investments made at different stages of the business cycle, the difference in average long-term performance has been very small over time.
For illustrative purposes only. Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indexes are unmanaged. Sample portfolio: 36% US stocks, 24% international stocks, 40% IG bonds. See disclosures for index definitions. This historical analysis is based on Monte Carlo analysis based on historical index returns. "Range of expected returns" illustrates simulations between the 25th and 75th percentile. The simulations represent an 85% confidence interval. Actual returns could potentially be higher or lower. Portfolio based on Dow Jones US Total Stock Market Index, MSCI ACWI ex-US Index, Bloomberg US Aggregate Bond Index, as of 3/31/2022.
Additionally, while recessions are certainly stressful and can present significant challenges to investors, they have often been relatively short and, historically, have been followed by larger, longer expansionary periods in which stocks have seen gains.
3. I don't want to invest because I'm concerned about volatility.
As interest rates rise, it's typical for stocks and bonds to experience volatility, but, like the turbulence on an airplane, it has rarely been a signal of some more significant concern. Historically, stock market volatility has been most pronounced in the months immediately before and following the start of the Fed's tightening cycle, largely dissipating as time goes on. As for bonds, volatility in bond prices may be less concerning given that, historically, most returns have come from bond yields over time, with price appreciation contributing a relatively small portion of total returns.
Maintaining composure during tough times
Understanding the relative effects that recessions, volatility, bear markets, and investor behavior have had on portfolios is a key component to making more informed decisions about when and how to invest. However, even this knowledge may not be enough to assuage investor anxiety when the market declines and portfolios suffer. Thankfully, there are methods available to help prepare for tough times and seek to avoid reactive decision-making.
- Make sure you have an emergency fund. Knowing you have enough money on hand to cover your essential expenses and any unexpected needs that might crop up in the event of an emergency can help give you the confidence to let your long-term investments remain in the market. (Learn more about establishing and maintaining your emergency fund.)
- Consider dollar-cost averaging. Instead of investing large sums of money all at once, dollar-cost averaging involves investing a portion of that sum on a regular schedule, perhaps monthly, regardless of what direction the market is heading in. Over time, this may help you purchase more shares when prices are lower. (Learn more about dollar-cost averaging during bear markets.)
- Consider investing defensively. Some economic sectors have been particularly resilient in down markets, especially those that offer essential goods and services, such as utilities, health care, and consumer staples. While past performance is never indicative of future results, investing in defensive sectors such as these can help investors feel prepared for what may come. (Learn more about defensive investing.)
- Explore a professionally managed account. With a managed account, investment professionals can help tailor a diversified portfolio in accordance with your goals and risk tolerance. These professionals manage your account based on these preferences and in accordance with a disciplined process of investing and asset allocation that helps to remove emotional or reactive decision-making from the equation. There are different types of professionally managed accounts, but all are geared toward providing you with the information, expertise, and resources to help stay on track during difficult market conditions. (Learn more about professionally managed accounts.)