Investing During a Market Downturn
Growing your wealth over time helps you reach your goals – especially when it comes to achieving financial independence. That’s the stage of life when you can generate enough cash flow from the wealth you’ve accumulated to support your lifestyle without having to work. If you’re like most of us, you hope to reach financial independence by retirement age, or ideally sooner. Investing, especially during a downturn, is a proven strategy of growing long-term wealth.
If investing is so great, why don’t more people reach financial independence? Why do I hear about people losing money?
Unfortunately, many long-term investors struggle to overcome unconscious biases and make decisions based on what’s happening in the short-term. All too often, decisions based on short-term thinking get in the way of long-term success.
When investment markets are down, why should I invest? And why shouldn’t I change my investment strategy?
Watching your investments go down in value isn’t easy. It’s a natural reaction to try to take control of the situation and take action. This is when the biggest investment mistakes get made – investors change their strategy or stop investing entirely. During a downturn, it’s especially important to remember why you started investing in the first place. Stay focused on your long-term goals and avoid panic selling that can make it difficult – or even impossible – to achieve your goals.
It’s important to remember that investment markets tend to move higher over time, but not in a straight line. They go through ups and downs along the way as economic and geopolitical events unfold. It’s expected that at some point in time, investment markets will face short-term challenges and lose value – the key word here is “short-term.” If you sell your investments because declining markets make you uneasy, you’re likely to miss out when they rebound. Markets always go up and down, just like a roller coaster. That’s called “volatility,” and it’s a normal part of the market cycle. What’s more is the best days in the market often soon follow the worst ones, and if you sell your investments on the way down, you’re likely to be watching from the sidelines when those best days come.
Research suggests that the pain of financial loss hurts nearly twice as much as the pleasure of a gain! It’s no wonder that fear can take over when people are losing money, but if you let emotion rule your decision making, you might cash out when your investments are at their lowest. The classic investment wisdom of “buy low and sell high” is easy to understand, but hard to do when your emotions are telling you to do the exact opposite during uncertain times.
Mistakes like this have the potential to diminish long-term returns. That’s because markets often sharply rebound immediately following a period of decline, with a large amount of the market recovery happening in the first few months of a rally. According to J.P. Morgan, the 10 best days in the market (S&P 500 Index) over the past 20 years occurred shortly after a major negative event (i.e., global financial crisis, COVID-19 pandemic) had caused the markets to decline significantly.
Unless you have a crystal ball that tells you when markets will hit bottom and start rising again, you’re typically better off ignoring short-term dips and staying invested. The graph below highlights the substantial drop-off in returns if an investor missed only a small number of the market’s best-performing days over an extended period of time.
This graph shows the wealth-destroying consequences of abandoning your long-term investing strategy by selling in volatile times and sitting on the sidelines holding cash. For instance, over the past three decades, if you merely missed the 10 best days for the S&P/TSX Composite Index (out of 7,500+ trading days), your return would be less than half when compared to remaining invested through the entire period.
Source: Morningstar Research Inc. S&P/TSX Composite Total Return Index from January 1, 1990 - December 31, 2021 using daily returns.
It’s all about perspective
Market cycles have existed as long as investing itself, and even though market volatility and alternating periods of strong and weak performance are a normal part of investing, there will always be people who sell indiscriminately during a market downturn. However, the following visual illustrates how volatility can be extreme in the short-term (the encircled light blue lines), but when you consider those brief periods of volatility in the context of the bigger picture (the dark blue line), they basically become inconsequential.
If you could’ve invested $100,000 in the S&P/TSX Composite Index in January 1977 – and stayed invested – your investment would have ballooned to $7,930,426 in just over four decades. This massive growth was not achieved without times of significant volatility. Earning attractive returns usually entails accepting some degree of risk.
Source: Morningstar Research Inc. Graph shows monthly returns while drawdown figures in text boxes uses daily returns. As at December 31, 2021.
How to invest when the market is down
So, we’ve been talking about the risk of selling in response to short-term market downturns, but what can you do to avoid this risk? Here’s three time-tested strategies to help you successfully navigate a market downturn:
1. Stay invested. Don’t cash out.
As long as you’re still invested, you technically haven’t lost anything, because your investment can still climb back. So far, your loss hasn’t been realized – it’s just “on paper.” But once you panic and move to cash, it’s game over. You’ve just locked in your loss and put yourself in a weaker financial position. If markets recover, which has been the historical pattern, you’ll miss out.
As a case study, consider what happened in 2008. The S&P 500 Index fell over 38%, which was its worst yearly percentage loss ever. For many investors, it was a time of panic. And yet, investors who had bought into the market before the 2008 financial crisis and held tight through the big decline would’ve posted solid returns a decade later. According to Morningstar data, if an investor were to invest $100,000 in the S&P 500 on June 1, 2008, they would have lost $51,000 by March 9, 2009 (the market bottom). However, by the end of 2019, their investment would’ve been worth $295,000.
2. Keep contributing to your investments
Downturns present an opportunity for long-term investors looking to take advantage and buy while the market is low, potentially paving the way for impressive gains. That’s why astute investors embrace volatility: it creates the chance to buy good-quality investments that have been “oversold” by the market.
The decision to invest should be based on your goals and personal financial situation. It shouldn’t be based on “get rich quick” investment ideas or hot tips on Twitter. An easy way to stick to your plan is by making regular investments through a pre-authorized contribution plan. You can contribute a fixed amount (e.g., $200) at regular intervals (e.g., monthly), which makes investing more convenient and disciplined.
3. Don’t try to time the market
Timing the market means you’re waiting for the perfect moment to trade, not just a good moment. That’s nearly impossible to predict, even for expert investment managers who spend their careers trying to understand the markets. It’s much harder for regular investors who lack the time and knowledge to constantly track the markets.
When it comes to your money and investments, don’t let the quest for perfect timing be the enemy of good timing. Every investor will experience loss. It’s how you react to those losses that largely determines your success as an investor.
Invest for long-term success
Set yourself up for success by having an investment strategy and sticking to it. Investing in a well-diversified portfolio with a healthy mix of stocks and bonds in different sectors and regions can make it easier for you to resist the temptation to time the market. Effective diversification helps to smooth out returns over the long haul, which may lead to a better investing experience. Most mutual funds and exchange-traded funds hold a wide range of investments. They allow you to build a resilient, well-diversified portfolio that can help withstand the impact of down markets.
The bottom line? When markets are down and fear is up, stay calm, reflect on your financial goals and maintain a long-term perspective. That’s how you’ll weather the storm, stay confidently invested when markets are highly volatile, and position yourself to enjoy sunnier days ahead.