The worse-than-expected May inflation reading was a tipping point for investors hoping inflation would reverse its trend and begin ticking down. The rude awakening came as the Consumer Price Index increased by 8.6% for the 12 months ending May 31, which the U.S. Bureau of Labor Statistics quoted as the largest 12-month increase in over 40 years.
Between June 6 and June 16, broader indices suffered the worst 10-day drop since spring 2020 as the Nasdaq Composite fell 11.7%, the S&P 500 fell 11%, and the Dow Jones Industrial Average fell 9.1%. Many stocks set fresh 52-week lows on June 16.
It can be hard to think long term when stocks continue to find lower lows. "I should have sold a month ago" is what folks will say when markets take a turn for the worse. There's no doubt that selling and walking away to stop the bleeding can be an emotional release. But it's usually a terrible decision for your financial health. Here's why holding through periods of volatility -- despite the pain -- is the best course of action during a bear market.
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Parallels between life and the stock market
The stock market has many similarities to life. It has its ups and downs. It can be driven by greed and fear. There are winners and losers; underdogs who defy the odds and kingpins that get knocked off their thrones.
Like many things in life, doing what feels good in the short term can inhibit long-term success and well-being. Selling your investments might feel comforting in the moment because it ensures that an investor can't lose more money. However, the opportunity cost of selling during a steep drawdown can be brutal.
Past performance shows us that it has always been a good idea to buy, or at least hold, through every single bear market in U.S. history. So far, it's a strategy with a 100% success rate, thanks to a steadily growing U.S. economy. Even though selling feels good, it can be a catastrophic mistake that leads an investor to miss out on years of gains. That's because it is very hard to buy back into the stock market after you've sold.
One reason buying back in can be challenging is because a market bottom isn't defined until it's already over. The bottom of this bear market could have happened last week. Or a new bottom could form in a few days. Or maybe in a few months, we'll realize the bottom is behind us.
During the worst of the spring 2020 COVID-19-induced crash, many folks were saying that the market could retest its lows. And by the time sentiment had shifted positive, the market had already staged an epic rally. When everyone is saying the market is going to keep falling and few are optimistic, it's usually a good time to be contrarian and take the other side of the argument.
The pitfalls of timing the market
Now if you had sold your stocks when the market was going to go down, it would take a rare amount of humility and grace to accept the mistake and buy back in at a much higher price. For that reason, few do it. And for those that have the courage to buy back in, it can be very stressful. When an investor isn't in the market, or not in the market as much as they would like to be, chances are they're looking for a way to get back in. It's classic timing of the market: when to get out, when to get back in, when to get back out, and so on.
What makes timing the market so hard isn't the ability to make one good decision -- it's that you have to make several good decisions for it to work.
Every time an investor sells, they are effectively going against the long-term uptrend of the stock market. Therefore, getting back in takes yet another good decision, and then if they sell, a third good decision. The whole ordeal is time-consuming, nerve-racking, and ultimately much more complicated and less effective than simply buying quality companies and holding them for several years.
A final point is that brilliantly timing the market in epic fashion -- such as selling right before a big crash or buying close to a bottom -- could produce false confidence that leads to subsequent market timing attempts that could result in more missed opportunities than gains. For example, many of the top stock pickers from Michael Lewis' The Big Short have had poor records since the financial crisis. Once you time the market once, it's hard not to try and do it again.
Delayed gratification is an investor's best friend
Avoiding the temptation to sell during a bear market isn't easy. What makes the decision much easier is to position your portfolio in companies that you believe can succeed for decades to come. That way, no matter how bad a sell-off gets, you can be confident that the businesses you've poured your hard-earned savings into can make it through the other side.
