The Importance of Staying Invested During Times of Market Volatility
Market volatility can wreak havoc on an investor’s emotions. The past several years have been no exception, notably the first quarter of 2020 (the beginning of the COVID pandemic) and 2022 have been two of the more tumultuous times in the investment markets’ history. Oftentimes, investors are faced with a difficult decision – when the markets are volatile, do I keep my money invested or do I leave the market and come back when things get better?
An area of finance that is becoming more prominent is behavioral finance, which is the study of the effects of psychology on investors and financial markets. Behavioral finance suggests that we are inherently bad investors, prone to basing decisions on emotions rather than evidence or facts. “We may think we’re making rational decisions, but we’re usually not,” says Tim Maurer, a certified financial planner who is the chief advisory officer at SignatureFD and also a member of the CNBC Financial Advisor Council. He goes on to say, “They are more likely driven by emotions, and then we rationalize them.”
It is important to note that these emotions are real and can cause significant stress to investors. Rather than labeling them as “incorrect,” it is important to control them. Emotions are not a sound basis for one’s investment strategy and research continues to show that active investors (i.e., attempting to time the market) underperform the market in the long run.
Research from Bloomberg and the Wells Fargo Investment Institute suggests that missing a handful of the best days in the market over long periods of time can drastically reduce the average annual return an investor could gain by holding onto their investments during selloffs (market declines). Their research suggests that over the past 30 years, missing the market’s best 20 days took the average annual return from 7.8% per year to 3.2%. Over the same period, an investor missing the best 40 days drops the average annual return to 0.3% and missing the best 50 days results in a -0.99% average annual return. Their research shows that investments, particularly stocks, accumulated most of their gains over the span of a few trading days.
Why is this important? Investors are ever aware of the effects of market downturns. The past few years have been very trying for investors and have caused significant stress and anxiety about their investments. Despite the volatility, the market has recovered following every minor or major market decline –including the Great Depression, the Global Financial Crisis of 2007-2009, and the COVID pandemic of 2020. Last year proved to be a devastating year for the markets but as has always been the case, it will recover in time. However, the time between now and recovery can be difficult and almost unbearable at times. It is imperative that investors use logic and sound financial advice rather than emotion when making decision regarding their investments.