The Long-Term Cost of Reacting to Short-Term Volatility
In the Canadian province of Nova Scotia, which is 80% dense forest and where hikers routinely get lost, schoolchildren are taught to “hug a tree and survive.”1
This isn’t because a tree can offer you warmth or companionship while you’re alone in the woods. It’s because sticking close to a particular tree will help you do the one thing most likely to lead to your rescue—stay put.
When people get lost in the forest, they invariably do one thing. They run (or walk as fast as they can) to get away from the place where they feel lost. Usually this takes them in a circle.
But wait a minute, you say. That doesn’t make any sense. How can you run away from a place if you don’t know where you are?
Exactly.
This fit of illogic doesn’t just affect a few excitable people. Search and rescue professionals will tell you it affects everybody. Even people with years of experience in the outdoors.
In fact, this exact phenomenon was noted by our ancient ancestors. They believed that the lost person had fallen under the influence of the forest god Pan. This belief is encoded in our word for this type of mindless fear—panic.2
As we’ve seen this past quarter, panic isn’t just linked to wilderness areas. It routinely affects people in the stock market.
October of 2023 seemed confirmation that the anticipated recession—the “hard landing” the financial pundits had warned us about—was finally here. The downward trend that had begun in August, appeared to gain steam in September, was by late October a correction of more than 10%.3
For many investors the stock market has only one acceptable behavior and that’s continuous growth. When they see weeks of volatility turn into months of decline, they experience the overwhelming urge to get out. And many did.
But by giving in to the urge to “do something” they not only turned their paper losses into real losses, but they missed out on days of unexpected market growth.
At the very end of October the leading indexes made a u-turn and began a 9 week period of expansion which saw the S&P 500 gain more than 11%, nearly half its growth for the year.4
The idea of selling in the early stages of a market dive and then buying back in right before it finishes its climb would be a valid strategy, if you owned a reliable crystal ball. Otherwise, it’s a proven way to lag behind those who simply leave their investments in place.
The problem is that since stock prices are based on all available information, by the time you find out about their movement you can assume everybody else has, too. And it’s too late to successfully speculate. This strategy only works if you can do the impossible—accurately anticipate pricing moves.
Researchers at J.P. Morgan Asset Management studied the implications of timing the market based on actionable information. They used data from Bloomberg to analyze the daily behavior of the S&P 500 Total Return Index over the past 20 years.5
They found that over the past two decades the market’s best days tend to come right after its worst days. In other words, if you jumped out of stocks during a major slide, you would not have been in position to benefit from their immediate recovery.
For example, if someone had invested $10,000 in the S&P 500 on January 1, 2002, and stayed for the next 20 years, they would have had a hypothetical balance of $61,685. (That includes weathering the crash of 2008 and the pandemic pullback of 2020.)
But if during that time they had missed just 10 of the market’s best days, they would have only $28,260.
That’s the cost of jumping out when things get rough.
“We often feel like we can take control of markets by selling out of them,” says Katherine Roy, chief retirement strategist at J.P. Morgan. “As a result, you lock in those losses and you are likely to miss some of those best days that are going to follow very shortly thereafter.”
Trying to time the market not only takes a financial toll, but an emotional one as well, as the investor can never rest from the quest for the obscure information or secret strategy that they hope will finally put them ahead.
If you ever have any questions about your investments or retirement plans, please feel free to give me a call at 801-545-0696.
Regards,
Mark Lund
Stonecreek Wealth Advisors, Inc.
11576 S State Street, Bldg. 1002
Draper, UT 84020
Sources:
1. https://acgsar.ca/hug-a-tree.htm
2. https://en.wikipedia.org/wiki/Panic
3. https://www.spglobal.com/spdji/en/commentary/article/us-equities-marketattributes-october-2023/
4. https://www.spglobal.com/spdji/en/documents/commentary/marketattributes-us-equities-202312.pdf
5. https://www.cnbc.com/2022/03/09/you-may-miss-the-markets-best-days-ifyou-sell-amid-high-volatility.html
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