The S&P 500 is an index that tracks the 500 largest public U.S. companies by market cap. The S&P 500 contains companies and industry leaders from every major sector, and its performance has become synonymous with the stock market's performance as a whole. It's how many investors gauge how well (or badly) the stock market is doing.
After an unprecedented 1.5-year rally following the 2020 COVID-19 bear market, the S&P 500 experienced a humbling 2022. The stock market's most popular index finished 2022 down more than 18% (including dividends). However, this shouldn't alarm long-term investors with time on their side. Here's why.
Embrace the inevitable
One thing to note about stock prices is that they reflect investors' thoughts, feelings, and actions, and since humans are known to be irrational, stock prices behave similarly. The one certainty in the stock market is uncertainty. Volatility is as much a part of the stock market as stocks themselves, and the sooner investors understand that, the easier it becomes to block out short-term noise and distractions.
Historically, the S&P 500 has been a great investment, returning around 10% annually over the long run. Countless people have retired comfortably by simply investing in an S&P 500 index fund consistently throughout their careers. However, it's not always smooth sailing.
In fact, since its inception, the S&P 500 has had a negative year (finishing in December priced below where it started in January) roughly a quarter of the time. Here are some negative years it's experienced since just 2000.
| Year | Yearly Return |
|---|---|
| 2000 | (9.10%) |
| 2001 | (11.89%) |
| 2002 | (22.10%) |
| 2008 | (37.00%) |
| 2018 | (4.38%) |
| 2022 | (18.11%) |
Data source: S&P 500.
Don't go against your long-term interests
The one thing you don't want to do during down periods is make short-term decisions that go against your long-term interests. This is particularly true about panic selling, which involves selling shares to "cut losses" or lock in profits before prices drop further.
Your portfolio's losses are unrealized, meaning they only exist on paper. If you buy a share for $200 and the price drops to $150, you've only lost $50 if you sell it. If the price increases to $225, that drop to $150 becomes irrelevant.
Panic selling can have two consequences. On one end, if you're panic selling to hurry and lock in profits before prices drop further, you can't forget about the potential tax bill. If you held the stock for less than a year, it'd be taxed at your income tax rate. If you held it for a year or more, it'd be taxed at a more favorable capital gains rate.
The second problem with panic selling -- and perhaps the biggest reason not to -- is that it takes away from any future value you could have gained. For perspective, here's roughly how the S&P 500 has performed since the down years from 2000 to January 2023 (excluding 2022).
| Year | Yearly Return | Return to Date |
|---|---|---|
| 2000 | (9.10%) | 195% |
| 2001 | (11.89%) | 245% |
| 2002 | (22.10%) | 339% |
| 2008 | (37.00%) | 355% |
| 2018 | (4.38%) | 51% |
Data source: S&P 500.
View down periods as an opportunity
Nobody likes seeing this portfolio drop in value, but it's all but inevitable at some point in your investing journey. I'm not above it, Wall Street experts aren't above it, Warren Buffett isn't above it, and unfortunately, you're not above it. But instead of viewing it negatively, it can be a good opportunity for investors.
Famed investor Warren Buffett advises investors to "be fearful when others are greedy, and greedy when others are fearful," and down periods are usually a sign that investors are fearful. Instead of slowing down or stopping investing, it could be time to embrace the drops and grab some great investments at a "discount."
Knowing that down periods are inevitable should give investors peace of mind that if they're investing in great stocks, the value will be there long term -- even if the short term is less than ideal.
