There are several basic investment principles: diversify your investments, reduce costs, and—perhaps most importantly—stick to your principles even when the market is volatile. That last principle is the hardest to adhere to. Watching your money disappear during market downturns is truly painful, especially when renowned figures predict that the world will collapse amid market crashes.
This was the case at the end of February when the U.S. stock market plummeted due to Covid-19. The S&P 500 lost over one-third of its market capitalization in just four weeks—one of the worst situations in history. Many believed that the pandemic would drive the U.S. into a prolonged recession and that the entire industrial sector would collapse, making recovery nearly impossible.
In such chaos, holding onto your stocks is a remarkable feat—and the surprising part is that most investors managed to maintain their positions. A recent report from Dalbar, an institution that analyzes mutual fund flows, concluded that “investors’ average preference for stocks did not change even during the Covid period.” Similarly, data from Vanguard Group, which manages assets worth about $6 trillion globally, revealed that only 0.5% of retail clients and retirement accounts were converted to cash between February 19 and May 31 during the crisis.
In contrast, during the 2008 global financial crisis, investors engaged in massive sell-offs—a dramatic shift driven by fear. This action was fueled by the prevailing belief that once a crisis begins, the market would never recover.
Yet, the market recovered sooner than many expected. Despite no clear signal that the coronavirus had completely vanished, the market began its upward trend by the end of March and recovered to pre-Covid levels by August. As widely known, the stock market started to rebound even eight months before news broke that a vaccine would be developed and administered—a near-accepted truth.
The dilemma for investors who sold at the onset of the crisis is now apparent. Since the market bottomed in March, the S&P 500 has surged nearly 60%. Thus, if you had sold your stocks near the high points before the Covid crisis—say, if you had invested $100,000 and then sold after a nearly 50% decline—you would have needed an $83,000 increase just to break even. In contrast, had you stayed in the market, your investment would now be worth $107,000—a return more than 30% higher than if you had sold.
The alternative, however, is even more dismal: waiting until the market nears a previous low that may never return. During the financial crisis, even without clear evidence that the financial system would recover, the market began its rebound in March 2009. By October—when all signals had become clear—the market had risen nearly 60%.
This is a familiar scenario. Investors who participated in the sell-off during the financial crisis faced similar challenges as those who exited the market during the Covid crisis. Those who re-entered the market during the 2009 recovery, despite concerns of buying at abnormal price levels, ended up earning over three times the returns of those who sold out in panic.
There are countless similar examples. Although there are exceptions, history shows that when the market surges from its deepest crisis points, it signals that those investors who stayed in were driving the recovery. Covid-19 is one such example, and investors must continue to adopt this mindset.
In other words, during crisis periods, instead of rushing to exit the market, focus on re-entering at the right time. No one can predict the bottom in advance. This means that re-entry can happen either too early or too late. Acting too early is unrealistic. If you feel the urge to sell when the market falls 20%, you likely won’t feel the impulse to buy when it rises 30% or more. The best course of action is to hold your current position.
(Source: Washington Post)
