The recent plunge in stock prices easily could prompt an average investor to bail out of the stock market. But that’s often a mistake.
There’s no denying how nerve-wracking a 1,000-plus points drop in the Dow Jones industrial average can be, especially when it happens twice in four days as it did last week.
The market also briefly suffered a correction — that is, a drop of 10% or more from its most recent high — and headlines about the nosedive made it seem the world was ending.
So, the temptation is to yank money from the market out of fear there could be more losses, with the idea that one will wait until the downturn eases and then reenter the market.
Indeed, last week a sizable 8% of the assets, or a record $23.6 billion, was pulled out of the world's biggest exchange-traded fund, the SPDR S&P 500 (or SPY), which tracks the benchmark Standard & Poor’s 500 stock index, Bloomberg reported.
Such funds are known as “passive” investments because they simply follow the movement of an index, as opposed to “actively” managed funds that pick individual stocks. But the sudden shift out of the SPDR S&P 500 showed many investors were hardly being passive themselves.
The temptation to sell is heightened by the fact that many investors would be cashing out profits because, until this month, the market repeatedly had climbed to record highs to extend its nine-year bull rally.
But that practice is called trying to time the market. And, for average investors, too often that doesn’t work because it’s difficult to predict the optimum time to get back in.
The result: Those investors often are late coming back to the party, arriving after stock prices turn back up.
Even worse, those who had bought stocks in January — as prices kept rising to all-time highs with barely any volatility in the market — likely locked in losses when they quickly sold off last week.
“Market timing is really, really difficult,” said Rob Austin, head of research at Alight Solutions, which tracks trading in 401(k) retirement accounts. “Some of us can do it, but most of us can’t.”
For example, in the last 20 years, the Dow’s five biggest daily percentage gains all came between October 2008 and March 2009 during the throes of the nation’s financial crisis and after the market had plunged.
It was a time when trying to guess the market’s bottom was extremely difficult. Yet it turned out to be the start of one of the longest bull rallies on record.
Still, it’s not easy to contain one’s emotions, and there was heavy trading among 401(k) participants last week, starting with Monday, Feb. 5, when the Dow plummeted 1,175 points after losing 666 points the prior Friday, Alight reported.
“Many 401(k) investors who spent the weekend hearing about how the stock market posted its worst week in years were quick to make changes and sell some of their equities,” Austin said.
So, what do analysts say is the best course for investors when the market plunges?
First is to remember the difference between investing for the long term and speculating on short-term market moves. For long-term investors in stocks, staying the course often is the best route because “over the long haul, stocks tend to be a really good investment,” Austin said.
For 401(k) participants, in particular, “there are plenty of plans out there that provide you with professional assistance or automatic re-balancing features” that allow those with retirement plans “to take the emotion out” of reacting to abrupt market moves, Austin said.
Another suggestion: Dollar-cost averaging, in which an investor puts the same amount of money into the market at regular intervals regardless of whether share prices are swinging up or down. That practice also reduces the temptation to time the market.
There’s also the age-old advice of diversifying one’s investments among stocks, bonds, cash and other assets to match how much risk an investor is willing to stomach.
Overall, “don’t panic,” said David Dietze and John Petrides, chief investment strategist and managing director, respectively, at Point View Wealth Management Inc.
“If you feel the urge to sell simply because the market is down, step away from the computer and go for a walk,” they said in a note to clients. “Don’t watch financial news media all day.
“Also, focus on percentage moves not point moves,” they said. “A 1,000-point move today is not as catastrophic as a 1,000-point move 25 years ago. Take advantage of the market sell-off.” That might mean buying stocks or increasing your monthly 401(k) contributions.
There are signs some are taking that advice to heart.
Vanguard Group, the mutual-fund operator with $5 trillion in assets that’s known for funds tied to the S&P 500 and other stock indexes, saw a record $190 billion in net inflows into stocks last year, and an additional $14 billion came into stocks in January.
Vanguard doesn’t have data yet for this month, but the company said in an email that “response to the market volatility [last week] was fairly muted as investors stayed the course, although we did see a rise in phone, web and app volumes.”