Stock market downturns are inevitable, unfortunately. And even though nobody likes seeing their portfolio's value dropping, downturns can actually be a good thing for many people and healthy for the stock market.
With the stock market currently in a bear market, there are at least two potential winners and one potential loser, and I'm not talking about individual stocks. Let me explain.
Winners: People with time on their side
Time can be a powerful force in investing. Not only does it fuel compound interest, but it also gives you time to recover from inevitable market downturns. Not all companies will survive market downturns, but it's all but certain that the major indexes and blue chip stocks will. Past performance doesn't guarantee future performance, but it's a really good indicator.
The S&P 500 is used by many as an overall indicator of how the stock market is doing. Even during some of the worst economic times in U.S. history -- like Black Monday (1987), the dot-com bubble (2000-01), the Great Recession (2008-09), and the COVID-19 pandemic (2020) -- it's managed to provide solid returns, IF you view it over the long run. The same holds true for the Dow Jones Industrial Average and the Nasdaq Composite.
There's a reason that conventional wisdom tells you to become more conservative with your investments as you get closer to retirement: You have much less time to recover if something goes wrong. If time is on your side, you can take on higher-risk, higher-reward investments to focus on growing your money instead of just preserving it.
Winners: People who dollar-cost average
If you're not careful, you can find yourself trying to wait for the "bottom" of a market downturn before continuing (or starting) to invest. After all, why invest now when you can get the same stocks cheaper later on, right? Not quite.
Even if you manage to time the market right once, it's all but impossible to do it consistently long term and sets a bad precedent. Instead of trying to time the market -- and risk getting the short end of the stick -- investors should use dollar-cost averaging.
Dollar-cost averaging is when an investor makes regular investments at a set schedule, regardless of how the stock or overall market is doing. Good stocks rising? Invest. Good stocks seemingly free-falling? Invest. Good stocks remaining stagnant? Invest. By sticking to a schedule and investing no matter what in the companies you believe in, you can prevent yourself from trying to time the market.
Using dollar-cost averaging during market downturns is also a great way to potentially lower your cost basis, which determines how much you eventually profit (or lose) when you sell your stocks. Your cost basis is the average per-share price you've paid for a stock, so the lower, the better.
Losers: Panic sellers are losing right now
Panic-selling is when an investor sees stock prices falling and decides to sell their stocks prematurely to either lessen their current losses or take profits before the price drops. Panic-selling is almost never the right move. Not only can it hurt you in the present, it can affect your financial future.
If you profit from panic-selling, you will also need to consider the tax implications. If you've held the investment for less than a year, profits will be taxed at your regular income tax rate. But if you've held it more than a year, it'll be taxed at your capital gains rate. Aside from the taxes, those are also shares that you never gave a chance to rebound and potentially produce better long-term returns.
You never want to make short-term decisions that go against your long-term interest. Keep your eyes on the prize, and stay patient.
