The economy is in a rough period and so is the stock market. Will the stock market continue to fall? Does this mean there is a perfect buying opportunity or should you try to time the market?
The perfect investment strategy is to sell your stocks before the market crashes. You then buy more when the stock market is tumbling. That’s the theory anyway. In practice it is much more difficult to predict if the stock market will continue to fall. This is because the stock market is constantly expanding and contracting. In any given week or month the stock market could have its best or worst day on record.
How do you ever know when it’s the right time to buy or sell? Stocks may crash 10% but they may drop another 40% before hitting the bottom. By contrast, stocks may crash 10% but rebound up 20%. There is always something in the news that suggests we are on the precipice of an economic meltdown.
Will The Stock Market Continue To Fall In 2022?
The year 2020 ushered in the Covid-19 stock market crash in April. Stocks rebounded to all time highs throughout 2021. 2022 hit a snag with soaring inflation, described as ‘Effing Crisis’! – “Energy, fuel and food”. 2022 has started with a poor earnings reporting season. War between NATO and Russia over Ukraine and Taiwan (backed by the U.S) & China is edging closer. 2022 is also expected to bring back to back rate rises, are all hitting stocks hard.
Supply chain issues, folding energy business and business costs are rising. Some suppliers are struggling to keep the lights on. logistical nightmares are everywhere and everything is generally getting a lot more expensive. The stock market was rocked at the start of 2022. Major stock market indices such as the Russell 2000 had fallen by as much as 20% by January. Which begs the question “will the stock market continue to fall” throughout 2022 and beyond.
As a result, you might think this a terrible time to start investing, or even that it might be time to sell up and cash out. When it comes to investing these are times that investors find most confusing. Often, it’s the selling part that leaves investors in a much worse position than when they started investing. The question that is on everyone’s minds, is “will the stock market continue to fall?
Disclaimer: This is not financial advice and you responsible for your own investment decisions. When investing capital is at risk.
Andrew | mr Money Side Up
Are You Looking For A Buying Opportunity?
Let’s assume that you are a responsible investor. You will have a carefully crafted investment strategy. It will contain a diverse portfolio of assets. For example, you might invest into something like the FTSE Global All Cap.
Let’s also assume that you have an emergency fund. Which will allow you to stay solvent in the event of a financial crisis. For example, a recession, contracting job market or increased cost of living. This will give you the option to sell down your investments or buy more at any given time.
Assuming all of this is true, you will want to know 3 things:
- Will the stock market continue to fall?
- When it the best time to know when to sell your stocks (e.g. is the market about the crash?
- When the market does fall, when it the best time to buy?
The Stock Market Is Highly Irrational
As I mentioned, this is great strategy is theory but in practice it doesn’t work. This is because our investment decisions are plagued by behavioural biases. The stock market is also almost impossible to predict. This is because many investors approach the stock market on an economical basis, which implies the stock market is a rational and predictable machine.
Many investors approach the stock market on economics only basis. This implies the stock market is a rational and predictable machine. In reality stock valuations are not a driven by pure economics. They are a consequence of the trading actions of people.
People prescribe a value to a stock based on sentiment. Human beings are notably irrational. By association, stock prices are irrational. Subsequently, so is the entire stock market. Traders get jubilant, traders panic and the everyday investor suffers. Many investors panic sell their investments when the market dips, drops and crashes. This has a more devastating impact than many of them realise.
What Happens When Investors Panic Sell Stocks?
Wells Fargo tested four hypothetical scenarios of investor behaviour. The data focuses on the March lows which resulted from Covid-19.
- Investor #1 (The dark-Purple Line): Increased equity exposure (added 30% more to equities, taken from investment-grade fixed income);
- Investor #2 (Light-Purple Line): maintained strategic allocations through rebalancing;
- Investor #3 (Red-Line): Red decreased equities (half of the equity exposure redistributed to cash and investment grade fixed income); meanwhile,
- Investor #4 (Orange Line): Completely exited equities.
You can clearly see that the investor type #1 outperformed the next best group by nearly 4.7 percentage points. This is more than 20 percentage point margin compared against the investor type that completely divested their holdings (type 4).
What Should You Do When The Market Crashes?
Panic selling is a common investor behaviour. It is natural to fear and want to avoid situations where you will lose money. It also makes sense that people want to jump into situations where they will gain money. This causes people to jump in and out of the market and damage their returns.
The idea that anyone can time the market is pure fallacy. This is because even if you are an expert at missing the worst days, you will also miss the best days. Missing the best days has a far more damaging effect on your portfolio that missing the worst days. Missing only 10 or 20 days of the stock market is disastrous for your returns. This is because the best and worst days of the market cluster together.
As a result, whilst you might miss a terrible day in the markets, you will also miss the rebound. In fact JP Morgan found that seven of the best 10 days occurred within two weeks of the worst days. Not only have the best and worst days typically clustered together, they often occurred during bear markets or recessions, when markets were at their most volatile.
What Is The True Cost Of Missing The Best Days Of The Market
JPMorgan calculated the impact of missing just some of the best days. They calculated the potential returns based on a $10,000 investment into the S&P 500 between 2000 and 2019. If you would have stayed invested through the entire period the average annual return would be over 7.47%. Your $10,000 would’ve grown to $32,421!
By contrast, if you would have missed 10 of those 5,000 days, it would have cut your returns to $16,180. You would have halved your returns in half by missing 10 days! 10 days!
It gets worse, you miss the best 20 days of the stock market. You would have reduced your returns to 0.68% and grown your investments to $10,167.
Do you still think you can time the market?
If you think you can predict this year’s 10 best days of the stock market, then feel free to try and time the market. I know for sure that I won’t be.
What tends to happen, is that we’ll have a deep sell-off in the markets. The next day traders will make the most of reduced stock prices. The fear in the market then creates buying opportunity. This buoys the market into an ecstatic and unpredicted rebound.
You see that it’s actually the volatility of the stock market that creates a lot of the extra value. Day traders drive market volatility but often lose money as a result. This is because they are selling at losses when the market dips, causing deeper sell-offs.
Passive investor then reap the benefits by continuing to buy a reduced prices. By pound cost averaging through the best and worse days, we capture everything. As we have seen, this works better in the long-run.
The Impact of being out of the market the day after a negative return
Being out of the stock market the day after a market has serious consequences for your returns. This is because of how the best and worst days cluster together. This chart details the performance of $10,000 investment January 3, 2000 to December 31, 2019. It’s definitely a warning against selling-off at what you consider to be the start of a market decline.
Hack Your Investing Psychology
Loss aversion can lead individuals to take control and sell equities after a market drawdown to avoid additional losses. This can result in missing some of the best days of return because those days tend to follow the worst days with very close proximity.
Automating your investment contributions has major psychology benefits. All you need to do is let your wealth manager allocate out this resource. This will also reduce the amount of interaction you have with your investments.
When the stock market is extremely volatile I am super-grateful that I don’t have to get involved. I don’t have to consider when is a good time to buy or sell. Instead I continue with the investment strategy of buying stocks once per month.
I also try to see the market movements from two perspectives. When the market is up, I’m happy because I’m making money. When the stock market is down, I’m happy because I’m buying stocks cheaper. In either case I know that the underlying value of the companies I invest into, will come through in the long run.
Key Investing Behaviours
Staying invested to benefit from those best days can be critical to a portfolio’s recovery. There are some key behaviours and investing features that can help with this:
- Professional portfolios: invest in responsibly managed funds with a reputable brokerage.
- Tailored Investment portfolios: select funds that meet your financial goals and risk tolerance.
- Regular rebalancing: Adjust your asset if there is too much deviation.
- Dividend Reinvestment: Purchase assets with the returns from your portfolio. This compounds your investment returns.
- Exchange-Traded-Funds: take advantage of fractional share technology. This means you don’t need to buy whole stocks. This allows for even greater diversification without a high investment minimums.
By simplifying all these investing decisions into as few decisions and using a passive approach, investing becomes much less stressful.
In Conclusion….
Trying to time the market is one of the worse things you can ever do. It is one of the primary reasons investors lose money in the stock market. It’s easy and more optimal to automate the majority of your investing decisions.
You can let your wealth manager or investing platform take care of it. Building an investing strategy you are comfortable with is essential. It’s the foundation of being comfortable market volatility. You want to be sure you can survive extreme market crashes.
Selecting a portfolio that meets you risk tolerance is key. You may want to balance your portfolio to capture both growth but not to fall to hard when the market dips. To smooth out this volatility you might want a 60/40 (stocks/bonds) allocation. You may also want to invest into a diverse range of companies, varying by geography, market cap or sector.
How To Select The Right Investment Fund For You
It’s also key to select an investment platform that can continue to rebalance your assets. You don’t want to be forever calculating you bonds vs stocks or buying and selling to rebalance.
This is why I invest in an ETF which contains a basket of index funds. I am full tilt towards stocks (as opposed to defence assets such as bonds) which is high risk in terms of volatility. However, this bucket of index funds results in in diversity upon diversity. This is a highly protective factor.
- Should you be invested in this high growth – high volatility approach then see my shortlist of 8 index funds.
- Should you want a more balanced approach. Check out my 5 US or 5 UK balanced funds.
- There may also be some value in adding alternatives to your portfolio. Check out the my articles on hedging against high inflation and where to invest in an asset Superbubble to find out more.
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