Author: Todd Campbell | January 02, 2019
Find the long-term winners in the short-term slides
The stock market’s sell-off in 2018 reminded investors that investing is risky, but history has proven time and time again that rocky markets can offer investors great opportunities to buy top stocks on sale. Here are five reasons why investors ought to buy stocks for the long haul when markets are anything but smooth sailing.
No. 1: Big one-day drops are meaningless
There were three days in the fourth quarter of 2018 when the S&P 500 Index ETF (NYSEMKT: SPY) lost more than 3% of its value, but historically, big one-day drops have little meaning for investors despite being unnerving. Not including this year, the S&P 500 has lost 3% or more of its value on 65 days since 2000, including 14 days since Dec. 31, 2009. Given the S&P 500 performance more than doubled since 2009 and it’s up nearly 70% since 2000, the right move has historically been to buy big one-day drops, not sell them.
No. 2: Corrections are more common than you think
Stocks enter correction territory when they decline 10% or more from their previous peak and that’s disconcerting until you remember that declines of 10% or more happen often. According to investment bank Deutsche Bank, corrections typically occur about once a year. Bear markets, or a decline of 20% or more, are less common, but they’re not unheard of, either. Over the past 90 years, there have been eight bear markets, or roughly one per decade. Buying stocks during those past corrections and bear markets have paid off handsomely for long-term investors.
No. 3: Time is on your side
WisdomTree reports that the median annualized return for stocks over any rolling 30-year period since 1871 is nearly 10%. Importantly, there weren’t any 30-year periods in which investors suffered a loss and the results were similar for other holding periods, too. There weren’t any rolling 20-year periods when investors lost money and there were only three inflation-adjusted periods that lost money over rolling 15-year periods. This data suggests the odds of profiting from buying stocks during rocky markets is very good for long-term investors.
No 4: Market timing is folly
The biggest argument for selling stocks when the market is falling is to free up cash that can be reinvested when the market bottoms. This “buy low, sell high” theory makes sense intuitively, but most people are horrible when it comes to timing when to buy and sell stocks. Instead, they tend to sell as markets near their lows and buy after stocks have already notched significant gains. To illustrate this point, a 2013 study by investment brokerage firm Charles Schwab finds that an investor who incorrectly bought the stock market at its highest point every year for 20 years through 2012 still outperformed someone who owned 30-day Treasury bills. And, a person who invested as soon as possible every year only underperformed someone who timed their annual investment perfectly by about 6%. It’s unlikely you’ll time the stock market top or bottom perfectly, so ignoring market timing altogether could be your best bet.
No. 5: It can lower your average cost
One of the best ways to build long-term wealth is to use dollar-cost averaging to invest in the market systematically. Dollar-cost averaging involves investing a fixed amount on a fixed schedule, for example monthly. If you invest a portion of your income every pay period in an employer-sponsored retirement plan, such as a 401(k), then you’re already using dollar-cost averaging. Because dollar-cost averaging allows you to buy more shares as stock prices fall than as they increase, embracing this strategy when markets are falling can lower your average cost and mathematically improve the likelihood of a positive return in the future.