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Investor psychology can be fickle. Imagine this common scenario: The stock market is going through a rough patch, and timid investors are getting out and parking their money on the sidelines, thinking it’s a “safer” way to weather the storm.
However, the calculations suggest quite convincingly that this is usually the wrong strategy.
“Getting in and out of the market is a loser’s game,” said Lee Baker, a certified financial planner and founder of Apex Financial Services in Atlanta.
Why? Pulling back during volatile periods can cause investors to miss the market’s most important trading days – and thereby suffer significant losses in profits.
Over the last 30 years, the… S&P 500 According to a recent analysis by Wells Fargo Investment Institute, the stock index delivered an average annual return of 8%. Investors who missed the market’s 10 best days during that period would have had a much lower return of 5.26%, it said.
Additionally, missing the top 30 days would have reduced average gains to 1.83%. According to Wells Fargo, returns would have been even worse – 0.44% or nearly unchanged – for those who missed the market’s 40 best days and -0.86% for investors who missed the 50 best days.
These returns would not have kept pace with the cost of living: Inflation averaged 2.5% from February 1, 1994 to January 31, 2024, the period in question.
Markets are fast and unpredictable
In short, stocks recorded most of their gains “in just a few trading days,” according to Wells Fargo’s report.
“Missing a handful of the market’s best days over an extended period of time can dramatically reduce the average annual return an investor could earn simply by holding on to their stock investments during sell-offs,” it said.
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Unfortunately, it is almost impossible for investors to time the market by staying invested on the winning days and exiting before the losing days.
Markets can react unpredictably – and quickly – to unknown factors such as the strength or weakness of a monthly jobs report or an inflation reading, or the outbreak of a geopolitical conflict or war.
“Not only are markets unpredictable, but these moves happen very quickly,” said Baker, a member of CNBC’s Advisor Council.
The best and worst days tend to accumulate.
One reason this is so difficult: The S&P 500’s best days “cluster” during recessions and bear markets, when markets are “most volatile,” according to Wells Fargo. And some of the worst days have occurred during bull markets, times when the stock market is on the rise.
Wells Fargo, for example, found that the top 10 trading days by percentage gain over the past three decades all occurred during recessions. (Six also coincided with a bear market.)
Some of the worst and best days followed in quick succession: Three of the 30 best days and five of the 30 worst days occurred in the eight trading days between March 9 and March 18, 2020, according to Wells Fargo.
“Distinguishing the best and worst days, as history shows, can be quite difficult because they often occurred within a very narrow time frame, sometimes even on consecutive trading days,” the report said.
The bill makes a strong case for people staying invested despite high volatility, experts said.
Entering and exiting the market is a loser’s game.
Lee Baker
certified financial planner and founder of Apex Financial Services in Atlanta
For further evidence, look at investors’ actual profits compared to the S&P 500.
According to a DALBAR analysis cited by Wells Fargo, the average stock fund investor returned 6.81% over the three decades from 1993 to 2022 – about three percentage points less than the S&P 500’s average return of 9.65% over that period.
This suggests that investors often make wrong guesses and their profits decrease as a result.
“The best advice, honestly, is to make a strategic allocation across multiple asset classes and effectively stay the course,” Baker said.
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2024-03-07 19:20:27
www.cnbc.com
