The global stock market has been off to a rough start this year, suffering a terrible downward spiral. Many investors fear the trend will continue and stocks will lose even more value, jeopardizing their hard-earned savings. Meanwhile, pundits on TV speak of a potential recession or, worse, a depression. Despite all the negativity, most investors should hold on during this downturn.
In every major decline we see nervous investors make the same mistakes. In early 2009, many people had enough of the stock market and decided to get out. They sold at a low point only to miss out on an enormous recovery over the next four years. Don’t let yourself make this mistake this time around.
Selling low and buying high
First, consider the research. Each year Dalbar, a Boston-based consulting firm, examines how average investors perform relative to what they invest in. And without fail, each year the firm’s report shows that average investors underperform their benchmark significantly due to bad behavior. The most recent report shows that the S&P 500 earned a 9.85% annualized return, while the average stock investor earned just 5.19% through 20 years ended Dec. 31, 2014. In times of market declines, the results get even worse.
The reason for the severe underperformance is simple: Investors who sell out during a downturn are selling low. They claim they will get back in “when things look better,” which is, in effect, saying they would like to get back in when prices are higher. This cycle creates the massive underperformance that Dalbar tracks every year.
Of course, it’s easy to understand the nagging feeling that we should do something when the markets decline. Our instinct when faced with a negative situation is to fix it. When it comes to investing, however, the only thing that will “fix” it is time, and unfortunately nervous investors don’t have a lot of patience.
During market declines we hear our friends, neighbors and the media constantly tell us how bad things are, which ultimately weighs heavily on our emotions. The best investors, such as Warren Buffett, can completely tune out that noise and stay disciplined during stock market declines.
Fighting the urge to make a change in your portfolio when the markets decline is one of the hardest parts of investing. It’s also one of the most important steps to achieving your long-term investing goals.
But amid volatility, it can be difficult to feel confident in your investing strategy. Fortunately, a well-diversified portfolio can provide some padding that offsets the decline.
This year, the unexpected hero has undoubtedly been the bond market. After a year of so-called experts suggesting that diversification has failed investors, the bond market has rallied strongly to prove them wrong. The U.S. Aggregate Bond Index is up 1.5% for 2016 (as of Feb. 16).
This is certainly not enough to make up for the stock market decline, but it’s definitely enough to provide a cushion to diversified investors. This cushion helps smooth out returns and makes it significantly easier to stay invested until the stock market recovers.
While experiencing a decline in your portfolio is difficult, the alternatives to staying invested look bleak. Research tells us that those who try to move in and out of the markets to avoid declines end up hurting themselves eventually.
This time, make sure you don’t sell yourself short by making preventable mistakes. Stay invested for the long run, and don’t let the downturn get the best of you.
This article first appeared at NerdWallet. Learn more about Steven Elwell on NerdWallet's 'Ask an Advisor.'