Welcome to Mr. Toad's Wild Ride. Please keep your arms and legs inside the vehicle while it's in motion. This is pretty much what it's felt like for most investors since the New Year's ball struck midnight and we moved into 2016.
The year began with the worst two-week period ever for the U.S. stock market. The Dow Jones Industrial Average (DJINDICES:^DJI), Nasdaq Composite (NASDAQINDEX:^IXIC), and broad-based S&P 500 (SNPINDEX:^GSPC) wound up falling 10.1%, 14.8%, and 10.5%, respectively, between Dec. 31, 2015 and Feb. 11, 2016. This drop was predicated on weakening growth prospects in China, falling commodity prices, and sub-1% U.S. GDP growth in the fourth quarter.
Then, the rollercoaster began reversing course. In spite of a few hiccups here and there, the Dow Jones closed higher on Thursday for the first time all year, the S&P 500 is down just a negligible three points for the year based on Thursdays close, and the Nasdaq is now off by less than 5%. Since the Nasdaq Composite is mostly weighted to technology and high-growth companies, and the Dow Jones and S&P 500 are substantially more diversified, it's pretty fair to say, even with the Nasdaq still down for the year, that the stock market has retraced the entirety of its early year losses.
For a number of investors this seemingly long-awaited rebound could be all the reason to cash in their chips and run for the exit. As for me, I have three much better suggestions of what you should do now that the stock market has put its latest correction in the rearview mirror.
1. Keep buying
The first thing you should do is not alter your investing strategy one iota and continue to invest regular amounts into the stock market each month, quarter, or whatever interval you normally stick to.
Why? Because trying to time the stock market is a fruitless endeavor that rarely pays off with any consistency over the long run. A study performed by J.P. Morgan Asset Management using data from Lipper between Dec. 31, 1993 and Dec. 31, 2013 of the S&P 500 showed that investors who held the index through thick and thin over the aforementioned 20-year period would have earned a clean 483%. Mind you, this involved holding through the dot-com bubble and Great Recession, which both wiped more than 50% of value off the S&P 500. A 483% return would handily have trounced the rate of inflation and added real wealth to anyone's pocketbook.
By contrast, investors who missed only the 10 best trading days over this roughly 5,000-day trading period would have witnessed their gains more than halved to 191%. If you missed the 30 best trading days your return dropped to less than 20%, and it was negative if you missed the 40 best trading days. Trying to time the market might mean missing a big drop or two, but it can also mean missing out on big gains (and without a crystal ball it's just not advisable).
2. Reassess your investing thesis
Secondly, it's never a bad idea to consider reassessing your investment thesis in the companies you own.
For example, consider going through each stock one by one and figuring out if the reasons why you bought that company over the long run are still intact. Chances are if you thought Facebook was going to dominate in social media and use its innovations and platforms to generate new channels of revenue, you still have the same opinion three months later. A little volatility didn't exactly change your investing thesis.
On the flipside, if you find that your investing strategy with a stock, or group of stocks, involves crossing your fingers, picking four-leaf clovers, carrying a rabbit's foot around in your pocket, or doing a rain dance, it might be time to consider yourself lucky enough to ride the rebound and exit your position.
The key point is this: if your original investing thesis is still intact and the business model is healthy, then there's no need for any hasty action.
3. Consider supplementing your portfolio with dividend income
Finally, in addition to checking up on what you already own and continuing to invest on a regular basis, consider supplementing your portfolio with stocks that could help you better withstand sharp moves to the downside. Namely, dividend stocks.
Dividend stocks provide three welcome benefits for investors. First, they're often the sign of a healthy company. Think about it this way: only a profitable company with a healthy long-term outlook is going to consider sharing a percentage of its profits with its shareholders. Secondly, dividend payments can help offset some of the sting associated with inevitable downswings in the stock market. And finally, dividend stocks allow for reinvestment opportunities, giving you ample opportunity to compound your wealth over time.
Dividend stocks are a smart consideration for your investment portfolio regardless of how well, or poorly, the stock market is performing.