The Most Dangerous Mistake Investors Make
Over the past week, market volatility has been building up. And this morning, it exploded. Minute by minute movements this morning were more extreme than most daily movements over the past four years. Many analysts point to concerns over the Chinese economy; however, other analysts point out that the magnitude of the declines far outweighs the economic impact of those concerns.
Regardless of the reasons, such volatility often causes any individual to want to react. So let’s talk about what impact those reactions might have.
We don’t know what the end of the day will look like (2 minutes after the open, the market was down by almost 6% -- over the next hour it had risen by 4%). And we certainly don’t know what the next few years will bring. However, let’s presume that over the past week, stocks will have declined by 10%. Since 1950, our research shows that there have been eight times in which the market has declined by at least 10% during a five-day period. In each case, there were a few investors who panicked and sold after that decline. During the next five years, on average, the S&P 500 increased by 74% (for an annual compounded rate of return of 12%). To put that number in perspective, the average five-year appreciation in the S&P 500 is 44%. Hence, selling after a decline locks in a loss, and misses out on what, on average, has been a great period to invest in stocks.
Fact One – Investors Who Sell After A Decline Lock in Losses and Eliminate Future Gains
We recently saw a startling research study by Dalbar, Inc. Between 1985 and 2014, the S&P 500 provided a return of 11% per year. However, the average investor in an equity mutual fund only earned 4% per year over that period. Why is that? Of course, fees explain some of that difference, but the overwhelming reason is poor timing decisions. Investors routinely “buy high and sell low,” getting into stocks after a market run up and selling after a market decline. Lest you think that investors have learned over time, in 2014, the amount of under-performance was 8%. In fact, in each of the past 15 years, the average investor in an equity mutual fund under-performed the overall market.
Fact Two – Investors Underperform the S&P 500 by 7% per Year Mostly Because of Timing Decisions
We understand the concerns over your portfolio. Individually, we advisors are also equity investors, and our values are fluctuating right along with yours. We welcome your inquiries, and invite you to email or call your advisor if you have more specific questions about the markets or your portfolio.
At Savant, we have always believed in steady asset allocation policy over the long-term. And our clients have been rewarded for sticking to that philosophy. Of course, philosophies are easy to follow during successful times, and more difficult to adhere to during times like these. But the facts are clear – investors benefit by not panicking during increases in market volatility.
While there is certainly a lot of legitimate financial news to cover today, never underestimate the ability of the financial press to act irresponsibly during turbulent times. The exacerbation of the fears and the commingling of opinion and fact are very disappointing.