The last quarter of 2018 has been very volatile for stocks, compared to the last several years of relative calm. This has made many investors nervous and potentially caused them to rethink their investment strategy. However, any investor who is surprised by recent volatility doesn’t really understand the historical movement of stock markets.
It would be great if we could all just sell our investments before major downturns and buy them back for a cheaper price than we sold them. However, no one is able to do that on a consistent basis. Luckily the market has always recovered from downturns.
Since 1900, the Dow Jones Industrial Average has dipped at least 10 percent on average about once a year, and 20 percent or more about every 3.75 years. Although the market has always recovered, many investors have consistently failed to participate in the recovery because they tend to reduce exposure to stocks after major downturns when the markets get too volatile. Since 1929 declines of at least 15 percent of the Standard & Poor’s 500 Index has been followed by a recovery that averaged almost 55 percent in the year following the major downturn.*
Therefore, it’s imperative that investors understand and expect their investments to have bad months or even bad years so that they will remain invested. The volatility is the price investors must pay to achieve stock market returns. Educated investors who expect the inevitable volatility will probably be more likely to resist the impulse to sell after a market pull back. In fact, since the data is undisputed that the average retail investor continuously under-performs the stock market due to selling stocks after downturns and buying stocks after rallies, it would be logical to conclude that it’s probably better to increase stock exposure after downturns. Even if the market doesn’t rally and recover as soon as we would like it to, if history is any indicator, stocks eventually will make new highs.
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