The last few weeks have been tough for investors. After a day of steep declines, stocks recovered for a day or two. And just when you thought the market had stabilized, prices dropped again.
It's like trying to catch a falling knife. If you don't do it perfectly, there's a good chance you'll get hurt. When it comes to your investments, you should avoid reacting to falling prices by jumping out of the market. In fact, being out of the stock market can prevent you from earning higher returns.
Here's an example: If you invested $10,000 in the S&P 500 Index on Jan. 1, 1989, never added another penny, and stayed invested through Dec. 31, 2010, you would have ended up with $73,383. That's an average annual return of 9.5 percent with all dividends reinvested.
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Let's assume you were out of the market for just one day, the index's best single day in those 21 years. You would have ended with $65,767, 10 percent less from being out of the market just one day.
And if you were out of the market on the index's best 10 days in that time, you would have ended up with only $36,623. That's just half of what you would have had from staying put.
This data shows the potential cost of playing the market-timing game, of jumping out of the market when you think it's heading lower and back in when you think it's on the rebound.
Without an investment plan—one that you believe in and takes into account your unique situation and goals—you might be compelled to sell during down times. Any decision to get out involves a second decision of when to get back in. If you're like most investors, you'll wait too long and miss the rebound. Remember, no one knows exactly when prices will hit bottom, and no one can accurately predict when prices will rise again.
Stocks don't go up all the time. Corrections of 10 percent or more are common—that's a normal pattern in stock market behavior. Every now and then, values can fall 20 percent or more. Fortunately, bull markets tend to last longer than bear markets.
No one likes to see the value of their investments go down. If you're very uneasy about how yours are performing, re-examine your risk tolerance and adjust some of your holdings. But you shouldn't make dramatic changes just because stocks are down at the moment. When the stock market is volatile and uncertainty takes over, you may discover that being out of the market is more painful than staying in.
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. Please note that it is not possible to invest directly in an index.