The stock market has been on an unprecedented run of success over the last decade or so. Here are the average annual returns of the S&P 500 over the last nine years:
2009 – 26.46%
2010 – 15.06%
2011 – 2.11%
2012 – 16.00%
2013 – 32.39%
2014 – 13.69%
2015 – 1.38%
2016 – 11.96%
2017 (so far) – 16.91%
That’s a pretty impressive run. If you put $1,000 in a S&P 500 index fund at the start of 2009 and just sat on it, you’d have $3,442 right now. That’s an amazing improvement!
Here’s how unusual this run is: it’s the second longest bull market in U.S. history (with a bull market being defined as a run of days in which the stock market has not declined 20% from the high water mark of that run).
That kind of correction, where the stock market declines for a while after a run of positive days and years, has always happened at some time or another. Stock markets don’t go up and up and up at a 10% or more average annual return forever. Eventually, something happens: Companies get too greedy, an unexpected major event happens, investors begin to move into other investments for some reason, or something else entirely.
The point is simple: Eventually, the stock market is going to correct – we’re going to see a run where the stock market dips 20% or more. The only real question is when.
Whenever things are this good for this long, people start getting nervous, even if there aren’t any telling signs of a coming decline. I’ve seen that nervousness in play in several reader emails, where people write in asking what they should do if the market is about to drop, even if they have no idea whether it will and have no evidence whatsoever.
Typically, these readers have a significant portion of their retirement savings in stocks and they’re worried about losing value. They picture their retirement savings falling by 40% or 50%, as happened in 2008, and they don’t want to see that happen.
So, what should you do if you think the stock market is about to start going down?
Here’s my answer: Nothing at all, unless there are a lot of extenuating circumstances. Let’s walk through the reasons.
First of all, the stock market is inherently a long-term investment, and this is a short-term factor. Making a big investment choice with a long-term investment based on some hunch that something might happen in the short term is a mistake.
The truth is that, unless you are a day trader or an investor who focuses deeply on the stock market in a professional way, money invested in the stock market should be heavily diversified and it should be a long-term “sit and wait” investment. The reason to cash out of it is because you’ve either arrived at the time where you want to put that money to work or you’re very close to that point. In other words, the stock market’s current activity should never drive the decision of an average person with regards to holding onto their stock investment.
Second, no one can ever really predict where the top of the market is going to be. The longest bull market of all time was several years longer than the current one (1987 to 2000) and this one could be even longer than that. Simply put, no one has any real idea where the top of the market is going to be or how far away it is.
Why does that matter? Let’s say that you sell everything now and move everything into cash, but then the market keeps going up for the next three or four years. Even with a significant correction, you’re still behind compared to just leaving it in place. You simply don’t know what’s going to happen going forward.
Third, even when the market does start to drop, no one can ever really predict where the bottom is going to be. It might be a rapid three-month correction that only drops 15%. It might be a three-year long correction that drops 55%. Again, no one can predict how long it will last and no one can point to where the “bottom” is except for in hindsight after things have gone back up quite a bit.
So, even if you’re completely right and now is the perfect moment to get out, you’re still very likely to miss the bottom of the market by a wide margin.
Combined together, these three big problems with pulling out now if you think the stock market is about to decline result in a situation that, unless you’re lucky, you’re probably not gaining much by pulling out tomorrow, even if some of those guesses go in your favor.
Hold on, though. Didn’t I say that there were a few situations where it’s okay to pull your money out of stocks right now? There are a few reasons.
The first reason is rebalancing. Many people have their retirement savings in a “target retirement” fund which does the rebalancing for them, but if that’s not you, you may find yourself in a position where you want to rebalance things. Let’s say, when you started investing, that you wanted to have 60% of your money in stocks and 40% in bonds. Over the last decade, your stocks have grown a lot faster than bonds, so you might be in a situation where 75% of your money is in stocks and 25% is in bonds. In that situation, it makes sense to rebalance – sell enough stocks to return yourself to the original balance you decided upon. You’re sticking with your plan, in other words.
The second reason is approaching your target date. If you’re getting close to your target date where you actually want to use that money, it may make sense to move some or all of it to something safer. For example, if you’ve been saving up to buy a house and have put some of it in stocks, and the time to buy a house is drawing close, you probably want to pull money out of stocks now because stocks are a long-term investment and you’re now focused on the short term. Note that retirement savings only partially follows this rule – when you retire, you’re likely intending to only spend a small portion of that money in the first several years of retirement, thus most of your money should stay in something aggressive but some of it should go into something safer.
There are other similar reasons, such as changing personal circumstances, where you may want to make a move right now, but the overall matter still holds true: Unless there’s a very good reason to do so, you should stick with your stock investments just as they are and ride through whatever is to come.
Stocks are a long-term investment. Sometimes they go up and sometimes they go down. No one can really predict when the switch between the two will happen. Making a guess can have some pretty terrible results for your investments, and guessing is exactly what you’re doing unless you are extremely gifted at stock investing.
Sit tight and enjoy the ride.
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The post What to Do If You Think the Stock Market Is About to Start Going Down appeared first on The Simple Dollar.