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.
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 can potentially 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 Morningstar Report from 2018, the market has always been up over every rolling 15-year period.
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 plan was likely built with very specific goals in mind with an asset allocation based on your time horizon and risk tolerance. 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 in your plans just like rushing to sell. Taking time to consider your long-term needs typically pays off.
Time in the Market Beats 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, if not impossible, to do. As a result, timing the market is not a strategy that works for most investors. Consider the following example:
In September of 2007 the S&P 500 closed at a high of 1,526.75. Even if you sold there—never mind at the crisis low of 735.09—you would have missed a significant rally. Ten years later , on August 14, 2017 the S&P 500 closed at 2,438.97.
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.
At this point, you may have noticed a potential contradiction. If people can’t predict the future, and it’s generally not a good idea to try to time the market, how is one supposed to identify market lows and seize on the opportunity to buy?
Luckily for investors, there are some strategies, like dollar cost averaging, that eliminate guesswork in favor of an investing regimen that can help you invest more when markets are low.
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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
There are some times when you may actually want to lock in your losses by selling low. When the market turns sour, you may want to consider tax loss harvesting. Maybe your eyes start to glaze over the second you see the word “tax,” but bear with me for a minute here. It’s important for investors to manage their taxes because they can take a bite out of your returns.
Tax loss harvesting is the practice of selling investments that experienced a loss in order to offset your gains in other investments. 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. Keep in mind 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. Sometimes, the best investment advice is not to give in to your feelings. Investing in a down market can seem like a scary proposition, but it can ultimately be a part of a balanced investment strategy that helps you grow your wealth over time.
If You’re Ready to Invest
Long-term investing may be one option to help you meet your financial goals, whether that’s retirement, sending a child to college, or buying a second home.
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