If you’re a long-term investor, you should be confident in two key beliefs before you act on your impulse to get out of today’s rocky stock market.
#1 You’ll Know When to Get Back In
Stock market sell-offs often seem to arrive out of nowhere. So do recoveries. Even if you time the sell decision perfectly, if you’re a long-term investor, you’ll need to buy back into the market eventually.
Since the market recovery began nearly seven years ago, the S&P 500 has risen about 178%. But the market’s upward climb has been punctuated by a series of pullbacks, as the Display below shows. There have been 17 different dips in which the S&P retreated by 5% or more. On average, it has taken about 31 trading days for the market to find a bottom—and about 30 trading days to reclaim the prior peak.
But recoveries aren’t marked by an “all-clear sign.” Indeed, the market often rallies despite continued investor concerns. Investors who sell during periods of market stress often feel the pain of loss twice: first, when they lock in their losses, and second, when they miss out on the eventual recovery.
The next Display charts the growth of $1 million in each of two hypothetical investors’ portfolios from January 2005 through December 2015, assuming a withdrawal of $50,000 per year. Both start with a portfolio allocated 80% to global stocks and 20% to bonds. The first investor maintained that allocation; the second panicked after a 30% loss in 2008, and sold stocks for cash, only returning to stocks in 2012, after an extended rally.
The steady 80/20 investor suffered a wrenching 46% loss in the 2008–2009 drop, but still wound up with $1,110,000 at the end of 2015, even after withdrawals. The market timer experienced a smaller, 38% loss, but ended up with only $630,000, or 43% less than the steady investor.
While this example is hypothetical, it mirrors the pattern of fund flows that resulted from the decisions of actual investors. Clearly, the difficulty of knowing when to get back in was extremely costly—even for those who timed their exit well.
#2 You’ll Come Out Ahead After Taxes
Equity investors gave up nearly half their returns to taxes over a 10-year span, according to “Taxes in the Mutual Fund Industry,” which Lipper Research Study published in April 2010. The odds of a costly tax bite are even higher now, because most investors have used up the capital loss carryforwards they accrued in the 2008–2009 market drop. And since the S&P 500 has nearly tripled from its March 2009 bottom, many stocks purchased in recent years are held at large gains.
Market timing is only profitable if you get back in at a lower price than you sold at. The tax hit from selling raises the bar: The higher the taxes you pay upon selling, the lower the price you need to get back in profitably.
It can be hard to stay committed to a long-term investment strategy in today’s market, but the evidence indicates that it’s the best course of action. The discomfort of hanging in during difficult markets is part of the recipe for long-run success. Investors who feel queasy during downturns need to remember the two key issues to consider before pushing the panic button.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.