When the stock market throws a tantrum for several days or weeks, it's natural to get nervous and be tempted to sell or change your investments. The last few weeks have certainly been a test of investors' ability to withstand sharp drops in value and increases in market volatility.
What's the best thing you can do during times of uncertainty and high volatility? Don't panic. That's easier said than done, and with investors reacting to news so quickly now, it's concerning when emotional selling sends the markets downward. But if you're patient and stay focused on your long-term goals, your investments can provide great rewards many years from now.
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Along the way, expect bumps in the road. Stock prices do not go up in a straight line. From time to time, declines of 10 percent or more are normal market corrections. We'd rather not deal with these corrections, but they create buying opportunities. Wouldn't you rather "buy low and sell high" instead of doing the opposite?
Larger drops are natural as well. Fortunately, those usually don't last long, and periods of rising prices last much longer than periods of declines. Even with all the ups and downs over the past 20 years, the S&P 500 Index posted positive annual returns with dividends reinvested* 16 times.
The last bear market, which occurred along with a global financial meltdown, lasted 16 months and took the S&P 500 down 55 percent. But that was preceded by a five-year run in which the S&P 500 rose 121 percent.
When the dot-com bubble burst in March 2000, the S&P 500 fell 47 percent through September 2002. That was preceded by an extended climb of 818 percent that started in November 1987. The down period lasted only about 2½ years after a bull run that lasted more than 12 years.
Including all the ups and downs, what kind of returns can you expect if you stay invested in the market? The average annual return for the index of S&P 500 companies (dividends reinvested) from 1926 through 2010 is 9.9 percent. The average had dipped to about nine percent in early 2009 following the deep losses, but the rebound in large-cap stock prices from March 2009 through December 2010 lifted the long-term annual average.
No matter how the stock market is moving, the best approach includes a healthy dose of patience. Resist any urge to move to cash when prices turn lower, and keep your money invested. You never know when the market will turn around.
That doesn't mean you shouldn't make adjustments along the way; as you go through life, your situation will likely change. You may also find that your ability to tolerate normal levels of market risk changes. Then it would be time for an adjustment.
If you remain calm and continue to put money in the market every month, you'll end up buying some shares at lower prices, allowing for greater profits over time. That can offset the impact of any market dips. Also, when prices start to rebound, you won't have to figure out the right time to get back in the market. Too often, market timing causes investors to miss out on the gains.
When there's a lot of uncertainty and worries bringing down stocks, the negativity can easily creep into investors' psyche. Find a way to tune out the daily noise of the market and stay focused on your goals. Remember that you're investing for the long term.
Have confidence in the investments that you've carefully chosen. You took time to consider your tolerance for risk and decided how to allocate your money among thousands of investments. Now, sit back and be patient.
Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast to coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations, and research to stores in The Mutual Fund Store system.
*All S&P 500 Index returns noted are with dividends reinvested.