What Should You Do When Markets Dip? (Hint: Nothing)
Selling off stocks when the market dips and returning only when things calm down is emotional, not rational.
It’s not yet Halloween, but many have already been spooked by the 3% drop in the market on Wednesday. Before giving in to panic and pulling your money out of the market, take a breath and heed this piece of advice from financial professionals: Stay calm and stay the course.
What does a stock market dip mean?
You may have seen these numbers being thrown around since Wednesday’s downturn: The Dow Jones Industrial Average tumbled by 832 points; Fidelity saw a 20% jump in its trading volume; Amazon’s CEO Jeff Bezos lost almost $10 billion within 24 hours. Those headlines would make anyone uneasy.
This week’s downturn was likely caused by the rising long-term rates, which increases borrowing costs and reduces corporate profits, especially since the Federal Reserve seems to be planning on raising short-term rates for the foreseeable future. In addition, as trade tension between US and China escalates, there have been continued worries about a slowdown in China’s economy, which drags down the broader market.
Just how bad was it?
Not that bad. As long as earnings and the US economy continues to grow, the dip could be a healthy market self-adjustment move. Plus, markets generally go up in the long term, and a recent volatility is unlikely to affect your long-term investment returns.
Many may not like precipitous drops, but in order to earn the attractive long-run rates of return on equities, investors must be prepared to bear the associated risks. In fact, risks are also the reason why stocks go up on average over the long run, and they ultimately reward you with investment returns. It’s all about balancing your risk and reward so that in the long term your overall wealth is steadily growing.
As Jakub Jurek, our VP of Research, explains:
“During the last 20 years alone, there have been 25 months (i.e. more than every tenth month) where the S&P 500 index dropped by more than 5% in a month, with the decline averaging -7.9% among those 25 months. Despite this, over this time period the annualized compound growth rate on the index has been +6.3% per year. “
What should you do?
Nothing. Selling off stocks and returning only when things calm down is emotional, not rational. Data has proven that we are always able to overcome dips and recessions successfully.
Imagine this: You had invested in an S&P 500 Index account during the market decline in late 2007. On January 1, 2008, you decided to pull out $100,000 from the market and put it into a savings account with a 2% interest. As of June 30, 2018, that account balance would be $123,000.
But what if you hadn’t moved your investment? Ten years later, you would have seen a 130% return, meaning your money would be worth $230,000 today — a difference of $107,000.*
“If you take money out of your accounts in anticipation over a market downturn, it’s hard to know when you should put your money back in,” says Celine Sun, Wealthfront’s Director of Research. “This means that most likely, you’ll miss the upside returns more than you’ll avoid the downside.”
Another good strategy to balance your risk and reward is to invest in companies in both developed and developing economies outside of the US. That way you can overcome the “home bias” and take advantage of foreign and emerging markets.
What’s the best way to weather these storms in the future?
Two words: passive investing.
Passive investing builds on the assumption that markets will grow over the long term, which is a safe assumption since global economies have consistently increased in value over the last several decades. And this trend is expected to continue.
By passively investing, you’re following the movement of the entire market rather than just a few stocks. As long as the entire market grows over time, your wealth will accumulate.
Passive investing might not make you a millionaire overnight, but it does help you take slow, steady, and calculated risks vs. the roll of the dice that is stock picking. Investors who passively invest are not looking to outperform the market; rather, they are looking to build their wealth over time. So if this is what you’re after, our advice is to ignore the news headlines and stay focused on the future. We know it can be emotional, but rest assured: Your money will be safe over the long term.
*Source: Wealthfront Research, 01/01/2008 – 06/30/2018.
S&P 500 return is based on SPY data (from CRSP)
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