What do you do with your stocks when the market goes down—a lot? If you’re like most people, your first instinct is to sell.
It’s human nature: When your investments go up in value, it feels great. But when your stocks go down, so does your faith in them, and you’re tempted to dump everything and hide your money under your bed.
But selling at this point may be counterproductive, and in fact, it may make more sense to invest while the market is down. Here’s a look at why.
Investing Is a Long Game
Seasoned investors know that investing in the market is a long-term prospect. Over time, market drops sometimes are nothing more than a minor stock market correction and, given enough time, your portfolio may recover from these temporary dips. According to a 2020 Morningstar Report , out of 80 overlapping 15-year periods since 1926, the market has always been up. Though the stock market is hard to predict, this pattern suggests that if you are invested in the stock market, you may come out ahead after at most 15 years.
However, buying and selling stocks based on emotions or gut reactions to temporary volatility can derail your investment plan, potentially setting you back. Your investment plan was likely built with very specific goals in mind, and the asset allocation was probably based on your time horizon and risk tolerance preferences. Impulsive selling can throw off this balance.
Instead of letting emotions rule the day, you might want to consider having a plan in place that includes ways of investing more when the market is down. Doing so is like buying stocks on sale, and the hope is that the downturn is temporary and you’ll be able to ride any upturn to potential earnings. So, when markets take a tumble, your best move is often to keep calm and carry on investing.
That said, any investment decisions you make should be based on your own needs. Just because the market is down doesn’t mean you have to buy anything. Buying stocks on impulse just because they’re cheaper might throw a wrench, just like rushing to sell. Taking time to consider your long-term needs and doing research typically pays off.
Timing the Market
Timing the market is the idea that by attempting to predict future market movements and buying and selling accordingly, you will somehow beat the market.
However, predicting market movements is exceedingly difficult. As a result, timing the market is not a strategy that works for most investors. Consider the following example: Starting in late 2007, stocks began one of the most dramatic plunges in their history. Many investors panicked and sold their holdings.
But the market bottomed on March 9, 2009 at 676.53, beginning a recovery that would turn into the longest bull markets in history. Four years later in 2013, the S&P 500 Index would surpass the 1,565.15 high it reached in 2007. While that more than 50% drop was terrifying, if you panicked and sold, you would have essentially locked in your losses and missed the subsequent recovery.
If, on the other hand, you had stayed invested, you would have seen stock values fall at first, but as the market reversed course, you may have seen portfolio gains again. This extreme example illustrates how holding stock over the long term can be a good strategy.
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Risks to Investing in Down Markets
That said, there are exceptions to these concepts that the market tends to snap back quickly or always trends upward. Take the stock market crash of 1929. Share prices would continue to slide until 1932 as the Great Depression ravaged the economy. The stock market didn’t end up reaching its pre-crash high until November 1954.
In addition, as of early 2021, the Japanese stock market still hasn’t reached the peak it hit at the end of 1989. Back then, the index went on to lose half its value in three years as an economic bubble in the country burst. However, the Nikkei 225–the benchmark stock gauge in the country–did touch the 30,000 level in February 2021 for the first time since 1990.
A scenario where stocks become overvalued and enter bubble territory is certainly possible. In addition, a fundamental rule in investing is to keep an eye on economic developments, such as inflation figures, job growth, manufacturing trends. The stock market is supposed to be a barometer for the economy as a whole after all.
And for stock prices to go higher, corporations need to demonstrate earnings and revenue growth. And for corporate earnings and revenue to grow, the economy–both the U.S and global–needs to be healthy and continuously expanding.
Understanding Dollar Cost Averaging
To help curb your impulse to pull out of the market when it is low—and continue investing instead—you may want to consider dollar cost averaging.
Here’s how it works: On a regular schedule—say every month—you invest a set amount of money in the stock market. While the amount you invest each month will remain the same, the number of shares you’ll be able to purchase will vary based on the current cost of each share.
For example, let’s say you invest $100 a month. In January, that $100 might buy 10 shares of a mutual fund at $10 a share. In April, the market dips, and the fund’s shares are worth just $5. Instead of panicking and selling, you continue to invest your $100. That month, your $100 buys 20 shares.
In June, when the market rises again, the fund costs $25 a share, and your $100 buys four shares. In this way, dollar cost averaging helps you buy more shares when the markets are down, essentially helping you buy low, and limits the number of shares that you can buy when markets are up. This helps protect from “buying high.”
Let’s say that after 10 years of investing $100 a month, the value of each share is $50. Even if some shares you bought cost more than that, your average cost per share is likely lower than the current price of the fund.
Steady investments over time are more likely to give you a favorable return than dumping a large amount of money into the market and hoping you timed it right.
Tax Loss Harvesting
If you’ve already experienced losses, you may want to consider tax loss harvesting–the practice of selling investments that experienced a loss in order to offset your gains in other investments.
Recommended: Automated Tax Loss Harvesting
Imagine that you invest $10,000 in a stock in January. Over the course of the year, the stock decreases in value, and at the end of the year, it is only worth $7,500. Instead of wallowing, you can sell it and reinvest the money in a similar (but not identical) stock or mutual fund.
You get the benefit of maintaining a similar investment profile that will hopefully grow in value over time, and you can write off the $2,500 loss for tax purposes. You can write off the full amount against any capital gains you may have in this year or any future year.
You can also deduct up to $3,000 of capital losses each year from your ordinary income. However, you must deduct your losses against capital gains first, before using excess to offset income. Losses beyond $3,000 can be rolled over into subsequent years.
During major market downturns, this technique can ease the pain of capital losses—but it’s important to consider reinvesting the money you raise when you sell, or you’ll risk missing the recovery. But remember that with investing comes risk, so there’s no assurance that a recovery will, in fact, occur.
It’s human nature to be concerned, or to feel panic at times. But sometimes, the best investment advice is not to give in to your feelings. Investing in a down market can be a part of a balanced investment strategy that helps grow wealth over time.
Long-term investing may be one option to help you meet your financial goals, whether that’s preparing for retirement, sending a child to college, or buying a second home.
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