Everyone knows: Around the world, gravity dictates that what goes up, must come down. Except, that is, in our topsy-turvy capital markets. Then, after markets go down, they are expected to eventually come back up, and to continue to ascend from there. At least they have to date.
In that context, let’s talk about an important No Dumb Question: Nancy, how do I make the most of market recoveries, so I can recover too?
It’s often assumed you’ve got to time it just right to capitalize on a market’s recovery. The thing is, it’s actually just the opposite. To capture a market’s expected long-term returns, I’m going to suggest that you can and should eliminate the nerve-wracking pressure of trying to time the market’s ups and downs and, instead, go with the flow.
Intrigued? Stay tuned for the rest of today’s “No Dumb Question,” so you can be ready the next time the market takes a bounce. Better yet, to make the most of your money across various market conditions, follow the bouncing ball by connecting with me on LinkedIn, subscribing to my YouTube channel and clicking on the bell!
What goes up must come down, right? While the laws of gravity are nearly universal, apparently our capital markets are out of this world. Even though it’s essentially inevitable that the markets will take a dive now and then, we also can expect them to recover, and even eventually sail right past their previous highs.
Do you remember, for example, this chart I shared last summer, when I addressed how to deal with difficult markets? [share chart from 3:43 in that script, updated with more current data if possible] As I said then and I’ll repeat now, the markets have been pretty consistent about delivering long-term returns – IF you stick with them.
To further illustrate how resilient our markets are over the long haul, our friends at Dimensional Fund Advisors shared this handy graph of how dramatically the markets recovered after the last several crises.
Those bold teal-colored bars soaring high above the 0% return line? They show us the cumulative total returns of a balanced portfolio of 60% stocks, 40% bonds five years after each of the last six market crises we’ve experienced. Clearly, these portfolios did okay in the long run, at least for those who sat tight in them, WITHOUT trying to bail out during the downturn.
“Yeah, yeah, I get it,” you may be thinking. Especially if you’re watching this during a period when all is calm and bright, it’s easy to assume you’ve got what it takes to weather the storms.
But if you take one thing from today’s “No Dumb Question,” remember this whenever the markets actually do take their periodic dives: Expect to be sorely tempted to change your mind. Seriously. Studies into behavioral finance have shown that when you encounter scary markets, your brain reacts in the same way as if you were about to step on a snake. Your brain floods itself with chemicals that spur you to recoil from the threat before you’ve even taken your next breath.
So it’s one thing to feel some panic during bear markets. Almost everyone does. But it’s another thing to act on your instincts, selling out when prices are depressed.
Because, then what? When the time comes for markets to recover, instead of already being there, ready to capture the upswing from the moment it begins, you’re left trying figuring out when it feels like the right time to jump back in. Since even professional economists can’t make that precise call until the moment has passed, trying to figure that one out is a recipe for lower expected returns and higher levels of anxiety. No thanks!
Instead, to make the most of a market’s recovery, your best bet is to force your calm self to override your impulsive self during the initial downturn. During a market crisis, assume you’re brain is under the influence of its own chemical brew. Stop, look and listen! And do nothing quickly, until your head can clear. By then, your investments may well already be on the road to recovery.
Of course your end returns will also be influenced by when you’ve entered the market to begin with. If your money has had time to grow before a market downturn, you might find it a little easier to sit tight.
I do have one critical caveat before I close. Markets are expected to recover after a crisis, but they can take years to do so. So what I’ve been talking about here is for your long-term holdings … not for the money you’ll need for potential spending during the next 1 to 5 years.
In fact, ensuring you have enough spendable assets to fund your ongoing lifestyle can also help you maximize market recoveries when they occur. By keeping enough spending money – or what I call Mattress Money – out of the stock market to begin with, you won’t feel as much pressure to sell your long-term holdings at inopportune times. This reinforces your ability to ride out the storms with the assets you do have invested.
