News outlets have been inundating investors recently with a bleak outlook for the market and economy due to the uncertain future of tariffs and their potential effects on inflation, stocks, bonds, and the overall economy. Uncertainty in the market can cause significant angst and fear among investors, which can sometimes lead to poor decision-making and suboptimal investment performance. However, high levels of volatility can give investors a chance to reevaluate their investment objectives, risk tolerance, and goals. Below are a few important principles to keep in mind while navigating market declines to help alleviate some of the pain associated with volatility.
Investors wouldn’t be human if they didn’t fear loss. Nobel-Prize winning psychologist Daniel Kahneman demonstrated this with his loss aversion theory, showing people feel the pain of losing money more than they enjoy gains. The natural instinct is to exit the market when it begins to decline, just as greed can prompt investors to jump in when stocks are performing well - both of which can have negative effects. Investors can overcome the power of emotion by focusing on relevant research, quantitative data, and time-proven strategies. Additionally, consulting with a financial professional can help investors navigate uncertain or volatile market environments.
Unfortunately, market downturns are part of the normal market cycle. Over long periods of time, stocks have trended higher, but history also shows us that market declines are an inevitable part of investing. On average, from 1954 to 2023, the S&P 500 has dropped 10% about once every 18 months and 20% or more about every six years. Each downturn, however, has been followed by a recovery and, over time, a new market high.
Time in the market always beats timing the market. No one can accurately predict short-term market movement, and investors who move money out of the market risk losing out on periods recovery and performance that follow downturns. Research from the Wells Fargo Investment Institute suggests that missing a handful of the best days over longer time periods drastically reduces the average annual return an investor could gain by simply holding on to their investments during market sell-offs. Over the past 30 years, missing the best 30 days (based on S&P 500 Index returns from February 1, 1994, through January 31, 2024) took the annual average return from 8.0% per year down to 1.8%, which was less than the 2.5% average inflation rate over that same period. In addition to staying invested during downturns, diversification can also help to mute volatility. By spreading investments across a variety of assets classes and categories, investors can buffer the effects of volatility on their portfolio.
Lastly, it is beneficial for investors to create an investment plan – and stick to it. Although emotional responses to market dynamics is completely normal and investors can feel quite nervous or uncertain, the actions taken during these periods can have profound effects on their investment success. A sound investment plan should address several aspects, including investment objective, short- and long-term goals, and risk tolerance.
Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.
All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.