The stock market is incredibly difficult to predict in the short term.
The market will decline on plenty of days, weeks, months and years — sometimes drastically so. No matter what prices do, it’s important to keep your eye on the retirement prize: Investing for retirement is a marathon.
Money expert Clark Howard’s investing advice virtually never changes whether the stock market is rising or falling.
In this article, I’ll provide context that may help you avoid selling your stock market investments at the wrong time. I’ll also pass along Clark’s advice for times of market turmoil.
Table of Contents
- The Stock Market Sometimes Crashes
- Create a Long-Term Investing Plan and Stick to It
- Explaining Dollar-Cost Averaging
The Stock Market Sometimes Crashes
If you track the stock market long enough, you’ll probably witness an epic crash.
It happened near the onset of COVID-19, during the global financial crisis of 2007-08 and when the dot-com bubble burst in the early 2000s. If history is any indication, it could happen again relatively soon.
However, the U.S. stock market has shown incredible resilience for the last 80+ years.
“Markets, even after a painful decline, eventually recover,” Clark says. “The younger you are, the more a decline in the market ultimately makes you money down the road, because you’re buying everything on sale for what, over your working lifetime, will probably recover many times over.”
If you could sell the minute before one of these crashes happens and buy the minute we reach the low point, that would always be better than simply holding. However, it’s essentially impossible to do that.
Anything other than perfect timing can cause you to miss huge gains, create an ROI-wrecking tax burden and perhaps equally as bad, cause you emotional turmoil and anxiety.
How Often Do Corrections Happen?
Pullbacks and corrections happen even more often than crashes. They’re healthy for the market in many cases.
The S&P 500 experienced a decline of at least 10% in 11 of the 20 years from 2000 to 2019, with an average decline of 15%. However, the market averaged a 6% gain in those 11 years that experienced big intra-year declines.
During that 20-year period, the S&P 500 averaged an 8.9% annual return. So in the years with major market pullbacks, the remaining parts of those years were more lucrative for investors than the years with no double-digit decline.
There are plenty of other stats that back up these points. Often the biggest stock market gains happen within a concentrated number of days, often in close proximity to a recent decline. If you try to time the market, it’s just as easy to miss those good days as it is to avoid the bad ones.
Create a Long-Term Investing Plan and Stick to It
If you’re susceptible to making emotional decisions when your investment portfolio is bleeding money (on paper), you may want to consider hiring a financial advisor.
Most financial advisors charge about 1% annually, which can be a huge amount of money over decades. But Clark says, for people who may panic sell at the bottom of the market, it’s probably worth the 1% and more.
“When the market goes through its inevitable swoons, a lot of people react emotionally and at that point, the main job of the financial advisors is to talk them off the cliff,” says Clark. “The hand-holding when the chips are down becomes a very valuable thing for a certain segment of the people who would panic sell.”
If you’re going to manage your investments by yourself, it’s important to create a logical financial plan. From there, you need to be able to stick to that plan come hell or high water in terms of short-term market pricing.
If you’re getting closer to retirement, and you’re invested in a target date fund (as Clark recommends), the fund will automatically move away from stocks and lower your risk profile. So you don’t have to worry about an ill-timed crash crushing your retirement plan if you’re in a target date fund.
Still far from retirement? Allowing the market to recover on its own is almost always the least risky choice.
“As long as you are invested for the right reasons — saving for your long term — and your money is diversified in a way that’s appropriate to your age, just ignore the headlines and hand in there,” Clark says.
Prepare for Crashes by Following Sound Financial Practices
Especially when the market is booming, it can be easy to invest too much of your net worth.
For example, Clark recommends that everyone work toward building an emergency fund with six months of living expenses. If all your investments are continually skyrocketing, maybe you’ll be tempted to take three months of expenses out of your emergency fund and put it in the market.
The problem is that you may be putting yourself in a nerve-racking position when the market inevitably crashes. What if you lose your job or incur some other significant and unexpected expense? If the market is now screaming downward, you may be tempted to sell into the panic.
It’s important to be prepared emotionally and financially in the event that a crash lasts for years.
How big of a crash would it take for you to feel uncomfortable simply waiting it out? And for how long would you feel comfortable doing so?
It’s good to prepare for those types of eventualities. Clark’s advice to hold through all the ups and downs is sound. But if you feel like you’re at risk — because a major crash would cause you to sell at a bad time — you may want to consider putting more of your net worth into something more liquid.
Explaining Dollar-Cost Averaging
Whether you invest in a target date fund, in low-cost index funds or in some other strategy, there’s a good way to avoid investing only when the market is peaking. It’s called dollar-cost averaging.
If you accept that most people aren’t going to predict short-term market movements in a way that’s going to lead to easy profits, this becomes easier.
With dollar-cost averaging, you simply invest a portion of your income each month or each paycheck. If your plan is to invest it all in a target date fund, just put 100% of your investible income into that fund each month.
Sometimes you’re going to buy at a market high point. Sometimes you’re going to buy at a market low point. By investing consistently over time, it’s likely that your “good” and “bad” entry points will average out.
So with dollar-cost averaging, you can eliminate the risk of buying into the market at the worst time — or holding your money looking for that perfect entry point while those already in the market enjoy gain after gain.
Watching your net worth dissolve in huge chunks is disconcerting at best, no matter how much investing experience you have.
Reacting emotionally to stock market prices is nothing to be ashamed about. It’s just important to separate your financial decisions from those emotions whenever possible.
When it comes to investing for retirement, that means sticking to your long-term plan and not letting current prices or market conditions change what you’re doing.