The Market is Dropping, What Should I Do?

Both the stock and bond markets have been under considerable pressure in 2022. As we write this article on March 17th, the S&P continues to hover around correction territory. There are several possible explanations for the decline – rising interest rates, an overvalued market, a potential economic slowdown, the Russia-Ukraine war, etc. But, given how complicated the markets are, any attempt to pinpoint an exact cause of the drop seems like nothing more than a Rorschach test for whoever is trying to do the pinpointing. In reality, some combination of all these (and, perhaps, other) factors is likely leading to the recent pullback in the markets.

While it is never fun for an investor to experience a market drop that impacts their portfolio, it is important to remember that market declines are a natural part of investing. Going back to 1950, the S&P 500 has experienced a decline of at least 10% once every other year. The same is true for the NASDAQ (which started in 1971) and the Russell 2000 (1979). While it would be great to avoid these downturns, it is impossible to time the market. No one can consistently know precisely when and how to avoid market declines. No matter how unpleasant it may feel, if you are invested in the market, you will experience many significant drops in value throughout your investing life. What matters most to your long-term financial well-being is how you respond to them.

Sometimes the declines worsen, and you end up with either a bear market (down 20%+) or even a dreaded crash (down 30%+). However, bear markets and crashes are much less frequent than corrections. If you panic and sell every time a correction occurs, you only end up harming your performance. For every correction that turns into a bear market or a crash, many more are short-lived and less severe.

The urge to do something is always strong. Unfortunately, our human instincts, honed over tens of thousands of years of survival in the wild, lead us astray in this situation. Our first impulse is to sell out and “stop the bleeding.” But this innate sense of survival can often be wrong. Think back to March 2020, for example, when the market dropped 30% in a matter of weeks as COVID spread worldwide. The desire to sell was strong (and many did), but it turned out to be the exact wrong move over the long run as the markets rebounded strongly and swiftly, quickly reaching new all-time highs.

Something important to note is that if you decide to sell out of the market, that is not the only decision you face. You must also choose when and if to get back into the market. Most investors who pull out usually wait for some promising sign before reinvesting their money. But markets are forward-looking; they tend to recover well before the good news shows up in the data or headlines. Thinking back to the 2008-2009 Great Financial Crisis: markets bottomed in March 2009, but unemployment numbers kept deteriorating until November of that year. If you waited for unemployment to stabilize, you missed a 60%+ recovery. This underscores the futility of trying to time the market consistently and highlights the tremendous negative impact that failing to do so can have on your portfolio.

The good news is that despite all the corrections, bear markets, and even crashes, the markets have rewarded those who stayed the course (or, better yet, rebalanced regularly). The compound annual growth rates for the S&P (+11.7%), Nasdaq (+10.4%), and Russell 2000 (+11.7%) have all been strong over the periods mentioned above. While it can be tempting to think that you might be able to improve upon those performances via adroit market timing, the sad truth is that you are much more likely to realize much worse performance. Study after study has shown that the average mutual fund investor materially underperforms the fund itself, a gap that poorly timed market bets can only explain.

Markets will not always go up, but they have rewarded the long-term investor over time. So while we know you get tired of hearing it, the best advice we can give is to stay the course and ensure that your portfolio is aligned with your financial goals.

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