Don't sell in a market downturn, Buy and Hold Index Funds!
With the market at all-time highs, there’s at least one interview or article in the financial news media asking if we’re at a market peak and if a crash is inevitable. “This is the second longest bull market in history,” knowing interviewees (from banks or financial advisory services companies promoting their firms) pontificate, “we are due for a correction.” “This market is overvalued” or “the Shiller Cape has surpassed dot com bubble and great recession peaks.” Okay sure the market does look relatively expensive with the S&P 500 with a trailing price to earnings (P/E) of 25.72-historic is more like 15-16.
Do not listen to the talking heads. Yes there will be a downturn but no one knows when this bull market will end. It is impossible to predict the next crash-recall no one saw the great recession coming. For all we know, the next downturn could be another two or three years away. You could be giving up huge gains worrying about a mild downturn. Because you’re an index investor who buys and holds your funds for the long term-you don’t have to worry about the day to day variations of the market.
The Buy and Hold Rules
- Do not sell in anticipation of a falling market-a crash could be several years away.
- Once the market does crash-do not sell! You’ll lock in your losses. Remember-if you’re an index investor the market rises over the long term.
- If you have the means (no worries of layoff and have fully funded emergency savings), continue buying during a recession-the stock market has basically gone on sale!
Let’s take the example below. Jack had $100,000 in an S&P 500 index fund January 1, 2005. The Great Recession begins-Jack tries to adhere to his buy and hold strategy. However, seeing his portfolio drop from a high of $138,000 October 2007 just a year before to $106,000 in September 2008 Jack decides to sell to prevent taking losses on his initial investment. Jack sits on the sidelines in cash throughout the recession. Feeling more optimistic he gets back into the market investing his $106,000 in the same S&P 500 Index fund. Today, Jack’s portfolio is worth $261,500. However, had he stayed in the market it would be worth $297,000. Jack missed out on $35,000 of returns.
Jack could have gotten out of the market just before the market peak and gotten back in just as the market hit bottom and made a killing. However, few are skilled enough to time the market in this way. Instead of trying to time the market, continue to invest regularly during the downturn taking advantage of dollar cost averaging. Dollar cost averaging is investing at regular intervals no matter what the market is doing. Sometimes you’ll buy high, sometimes you’ll buy low but over long periods you’ll minimize your risk of investing large lump sums at market highs. If Jack continued to invest during the downturn he’d have been investing new dollars at market lows. $100 invested February 2009 would be worth $438 today. Because, as we now know, the S&P 500 went on to record highs in 2017. That’s the power of compounding and investing “when others are fearful”.