There's quite a bit of truth to the idea that time in the market matters more than timing the market. Since it's not possible to know what the future holds, fears of a recession shouldn't stop you from making periodic deposits to your investment accounts. As we'll discuss, if you're a long-term investor, the best thing you can do is to continue to invest -- even if the stock market tumbles in the short term.
Here, we'll discuss why you should keep investing even if you're experiencing a bit of stock market anxiety.
Time horizon is the key variable
For investors nearing retirement, feeling nervous about a recession makes a ton of sense. They're nearing the point at which they'll need to withdraw from their portfolio, which can be problematic if their asset allocation is almost entirely stocks. A potential fix in this scenario is to adjust to an investment mix that isn't quite as volatile, like 30% stocks and 70% bonds, for example, rather than cashing out of the stock market entirely. Rash, emotional decision-making can cost thousands over the long haul -- even if it alleviates short-term worries.
If, on the other hand, you're many years from retirement (think 10+), recessions and market downturns should be seen as both expected and normal. This is much harder to feel when your account balances are down, but it does reflect the reality of stock investing. Fluctuations will happen, but over long investing periods the probability of losing money is zero or close to it, depending on the length of time in question.
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The silver linings of a market downturn
If we do fall into recession and the stock market responds in tandem, you'll see your account balances fall. While it might be painful to log in to check the numbers, there are a few things still working for you:
- More shares at a lower price. Assuming you keep investing even when the stock market is down, you'll buy more shares with each new deposit than if the stock market had surged over the same period. In other words, stocks are on sale.
- Reinvested dividends purchase more shares. Following the same logic, all reinvested dividends will buy more shares than when the market was higher. Example: If a stock's price were to fall from $10 to $5, a $1,000 dividend would buy 200 shares instead of the 100 it would have bought previously.
- You'll find out if your asset allocation is too risky. If you're not emotionally prepared to deal with any sort of stock market volatility, a market downturn will quickly let you know that. In other words, if you're investing too heavily into stocks, you'll feel it as soon as markets turn south and balances decline. The fix: Adjust your asset allocation to something more comfortable.
- If you don't sell, you'll maintain your holding periods. Selling out of your taxable positions when the market is down is exactly the sort of behavior that hurts you in more ways than one. Importantly, jumping out of the stock market resets all your holding periods for tax purposes. The IRS favors investors who hold stocks and bonds for longer than a year; if you sell out before a year is up, you'll not only pay more tax on any gains realized, but you'll also have to restart your holding periods.
- Doing nothing helps develop discipline. Acting on emotion and selling out of your stocks during a recession doesn't help you in any meaningful way. Selling not only makes it impossible to know when to reenter, but by the time you may want to enter again, there's a good chance you'll have missed out on much of the upward swing.
This is all to say that a recession isn't going to feel good, and it isn't supposed to. But it does remain the case that those who stay the course -- even despite big stock market drops -- are those who will reap the long-term financial benefits.
Emotions and behavior will dictate portfolio returns
Before you start investing, it's key to understand that you'll need nerves of steel to become a successful long-term investor. The world's best investors have lived through war, conflict, financial distress, social upheaval, and many other unpleasantries on their way to becoming some of the wealthiest people on the planet.
It's crucial to consider your risk tolerance and time horizon before committing too much of your money to the stock market. If you're a long-term investor, though, the best strategy during a bear market is to simply keep investing -- even when your heart tells you to pull your money out. Following this simple yet difficult principle is one of the most reliable ways to achieve financial success over the course of an investing career.
