Benefits of long-term investing
Beware of emotional investing
Feeling dissatisfied with your investment returns? You are probably not alone. Studies by financial research firm DALBAR consistently find that the returns of average investors fall below those of the overall stock market.1 But the reason why may surprise you. It’s not that average investors aren’t paying attention to their investments; instead they may be too focused, and at the wrong times.
As with so many things in life, emotions are partially to blame. When the stock market is climbing to new heights, it’s normal to want to jump in for fear of missing out. When stocks fall fast, it makes sense to want out at any cost. But these instincts can lead to poorly timed decisions.
Focus on time not timing
Attempting to move in and out of the market at ideal times is known as timing the market. It’s generally not recommended because it’s nearly impossible and can have serious consequences. Quitting when the going gets tough could mean locking in losses. If the market rebounds (and historically it always has) you miss out on the next upswing. And reinvesting when the market hits another peak is like buying something when it’s no longer on sale.
It’s important to consider how the market has traditionally behaved. It has good years and bad, but generally has trended upward over time. Of course, past performance is no guarantee of future results, but the market has done particularly well over longer periods of time.
Go for a goal
One way to take emotions out of investing is to start with a goal. Defining your reasons for investing can help you manage your expectations.
For example, if your goal is in the near term, and you’re investing money you will need in five years or less, stocks probably aren’t for you. The volatility will almost certainly wrench your emotions because you have too much at risk.
If your goal is for something like retirement, and it’s 10 or more years away, the risk of stocks may be more tolerable. You may also want some bonds, which can help smooth out the impact of stock market swings. A thoughtful mix of investments, or asset allocation, can help you stay invested even when the market acts up.
Make good habits automatic
Your long-term plan could also include a commitment to steadily invest a fixed amount regardless of market conditions. For example, you could automatically transfer $100 from each paycheck into your investment portfolio. This helps you make investing part of your routine, instead of something you do on a whim.
Automatic investing also helps you do something called “dollar cost averaging,” which is investing at different prices. When investment values are down, your money will buy more shares. It’s like taking advantage of bargain prices. Making automatic contributions to a retirement plan is a prime example of dollar cost averaging.
Limit the updates
Another strategy for softening the emotional impact of a downward market is to check the value of your investments only at regularly scheduled times. Rather than looking every day, you could review your account statements quarterly or annually. Focusing on long-term results makes you less likely to have kneejerk reactions to day-to-day market swings.
There may be moments when you want to react. History has shown that stock market declines are an inevitable part of investing. And these drops are more common than you might think. The S&P 500 Index has typically dipped at least 10% about once a year, and 20% or more about every six years, according to data from 1950 to 2019.2
During those dips, it helps to remember that every S&P 500 decline of 15% or more, from 1929 through 2019, has been followed by a recovery. The average return in the first year after each of these declines was 54%. You wouldn’t want to miss that. While past results are not predictive of future periods, those rebounds can make it worth waiting out the drops. You can’t invest directly in an index, but it can be a good reflection of the market in general.
Keep calm and stay focused
The bottom line is that emotional reactions to market events are perfectly normal, and it’s no surprise that we may get nervous during periods of uncertainty. But taking impulsive actions can mean the difference between investment success and shortfall. Remember, you can’t control what happens, but you can control how you react.
1 Source: DALBAR’s Quantitative Analysis of Investor Behavior, 2020
2 Source: RIMES, Standard & Poor’s