Why panicking is the worst thing to do in a financial downturn
During a period of decline in the market, many individuals feel like they are losing their shirts (and possibly much more).
Remember, corrections happen often. Technically, so do recessions. We typically have a correction once every couple of years and a recession every 5 years or so. That said, the overall equity market still returns just under 10% over the last 200 plus years.
So what might one do amidst a significant financial downturn? Suggestion: hold on tight!
How often do these "market crashes" happen exactly?
According to USnews, corrections happen at least once every 2 years. Sometimes they happen annually. When corrections do occur, they typically only last a couple of months and drop less than 20%.
Bear markets (recessions) occur every 4-5 years. They typically drop 20% or greater and last for a duration of one year, give or take a few months.
The worst meltdowns or recessions in recent memory was "The Great Recession". That sucker lasted 18 months and was the worst meltdown since World War II. During that period, the S&P 500 lost approximately 50% of it's total value. Now that's scary stuff!
How long does it take to recover from a typical market dip?
The single most significant factor of a recovery whether or not you stayed invested throughout the entire downturn.
As history has shown repeatedly, if you choose to try and time the market and you get out while it's on the way down, you technically have to time the market correctly twice- once on the way down, and then once on the way back up when you "re-enter" the market. Market timing is a fool's errand.
There are professional money managers who spend their whole entire life's work trying to time the market and, guess what... 92% of actively managed funds fail to match the returns of the market (i.e. S&P 500 index) over a 15 year period.
That means if they cannot do it, why would you even try? You don't have the time to sit around and read financials all day like these guys do.
As for how long the typical recovery takes.
In a correction, you should be back to even within a couple of months. For recessions, you usually get back to square within 18 months, give or take. Regardless, the markets have always climbed back and resumed breaking records. This is no guarantee but it seems highly likely given that we have two centuries of market data to rely on.
What to do when things get scary
My personal philosophy, as well as the philosophy of many seasoned investors, is to sit tight. Selling when the market is falling is one way to guarantee a financial loss and give yourself a lasting bad experience with investing in the market.
For the bravest of the brave, you could take this one step further and actually invest during a downturn. This is what I personally do. I take advantage of funds going "on sale" and purchase shares of the index funds that I already usually invest in at a drastically lower price than I would have gotten if the market continued to climb. See my thoughts on low cost index funds if you are unsure what these are.
It was the infamous Warren Buffet who said when the sky is raining gold do not go outside with anything less than a washtub. This is the very basis of the saying "buy low".
If you happen to be an individual stock picker, and not a typical index fund investor, then I suggest you go elsewhere for information because this is not a game I like to play.
When you invest in index funds like the S&P 500, you are betting on the entire US economy. Realistically, in order to lose ALL of your money, the entire country would nearly have to "go out of business" and I just would not bet on that happening anytime soon. Beside, even if the U.S. economy completely tanked and all businesses closed up shop, there will be much bigger problems going on in society that will quickly overshadow your worries about how much money is in your account.
If you are invested in broad based, low-cost index funds, then I would plan to stay the course and avoid selling in a downturn. You lose money when you sell or when a company goes out of business. If you stay invested, particularly in these broad index funds, the likelihood of never returning to baseline is slim to none.
If you had a crystal ball and could see things coming, perhaps you could adjust your asset allocation (i.e. more bonds and less stocks) prior to or immediately after the beginning of a downturn. The problem is, nobody is able to time this. Most of the corrections and recessions have no consistent way to assess when another one is coming. The best you can do is decide whether you think major market fluctuations are ahead based on national news - think politics and pandemics.
For example, take the onset of the coronavirus (COVID-19). If you had first heard of the potential outbreak on the news January of 2020, perhaps you could have adjusted your allocation more towards less-volatile bonds to soften the blow. Nevertheless, things were able to return despite the fact it seemed the downward spiral would never end. If you are considering yourself a long-term investor (which I hope you are), perhaps ignoring these events altogether is your best bet. Ask your financial pro if you don't believe me and if he disagrees, find out why (it usually revolves around him or her making an extra commission to manage your funds).
In the end, no results are guaranteed. Past history does not indicate future returns. Besides, none of this is investment advice and I am not a financial professional. You have to take the good with the bad. The overall average returns of the market of just under 10% per year include years where the market dips greater than 50%-such as what happened in 2008. You truly do have to take the good with the bad when it comes to investing.
In closing, corrections happen all the time. Further, we are never that far away from a full recession. They are coming. They will continue to come. Be prepared. Be ready to see your accounts lose massive value. This are the harsh realities. If you cannot handle it, maybe you should go bury that money under the shed and let the worms get it.
I started this blog because friends and family often asked me similar questions regarding personal finance. I was surprised just how much people were interested in improving their financial situation, yet had no idea where to start. It made perfect sense to start a blog and share all the information that I have learned along the way with others. You will find many resources and links referred throughout the blog. I have found all of this information useful and continue to grow my knowledge and understanding in the personal finance space. Admittedly, even I struggled heavily in the beginning with understanding how to improve my financial situation. The power of reading and note taking got me where I am today and will continue to provide a return on investment for years to come. I look forward to sharing with you along the way.