What to consider before getting out of the stock market
As the economy enters the second half of 2020, economists anticipate a market rebound. However, the potential threat of a COVID-19 resurgence may lead to a smaller bounce back than expected.
Over the past month, the number of COVID-19 infections in the United States surged significantly as states attempted to ease quarantine restrictions and reopen their economies. 1 Due to concerns about a more prolonged economic recovery, equity markets began to slide again. This market volatility may leave investors feeling uneasy and questioning whether now is the appropriate time to take their money out of the stock market. While selling your assets and moving into cash may feel like a comforting decision during this uncertain time, drastically changing your asset allocation usually is NOT the course of action you want to take. Here’s what you should consider.
A loss isn't really a loss
When the market trades down and you see the value of your portfolio decrease, it feels like you’ve lost money. Well actually, you haven’t. You only incurred what’s called a paper loss or a change in value. You’ll be comforted to know there’s a big difference between the two. A paper loss, also referred to as an unrealized loss, occurs when the value of an asset drops below its original price, but the investment isn’t yet sold.2 The real loss comes from selling your investments lower than when you purchased them. When you pull your investments amidst a market decline, you miss the opportunity to have your investments rebound as markets trade higher. Keep in mind that every Bear Market we’ve ever experienced has been followed by a market rebound! Let’s take a closer look at these market cycles.
The Bull Vs. Bear Market
A bear market is defined by a market decline of at least 20%. Although this can feel like a frightening time for investors, here’s why you shouldn’t panic. History has shown us time and time again that proceeding a bear market is a bull market. A bull market indicates a market rise of 20% or more in broad-based market index funds for at least two months. Keep in mind, that historically, markets begin to rebound well ahead of an economic recovery.
The Great recession is a great example to study. The S&P 500 lost 54% of its value during that bear market period lasting from October 2007 until March 2009. Once again, history repeated itself where many investors pulled out of the market closed to the bottom of the market. But the proceeding bull market was characterized by an S&P gain of nearly 100% inside of five years. The bottom line is that maintaining your investments in a bear market may result in a great return.
Market Timing Doesn’t Work
Market timing is an investment strategy where investors move in and out of the financial markets in an attempt to dodge losses and buy in at the bottom of a market crash. Put simply, the strategy is to buy low and sell high. Though this may seem like an appealing investment strategy, when an investor pulls their money from the stock market, they risk missing out on substantial returns when the market surges.
Market timing temptations are really strong during periods where the stock market is at record highs. You’ll anticipate that the next big crash is soon to follow. But the reality is it’s not so easy to time a market bottom. Any investment involves some level of risk but trying to avoid risk by timing the market only creates more risk. Since there’s no way to know when exactly the market will reach its bottom, it’s best to stick with your current investment strategy.
Understanding your risk tolerance
Understanding your risk tolerance is one of the most important considerations when investing your money. Risk tolerance is quite simply the degree of volatility that an individual is comfortable with. Given the strong market rebound since the March low’s, now is a great time to revisit your personal risk tolerance. In assessing your risk tolerance, consider what action you would take if your portfolio dropped 10%, 15%, 20% or more. It’s obvious that no investor likes seeing their portfolio drop in value, but when assessing your risk tolerance, think about what actions would you take if you did experience a loss. If you do think that a significant loss would cause you to lose sleep and sell out of your investments, now may be a good time to become more cautious. If on the other hand, you feel that you would ride out a market pull back, it may be best to leave your allocations in place.
How can a financial professional help?
A financial professional will work with you to help assess your risk tolerance and build an asset allocation in alignment with your risk tolerance and financial goals. Through financial planning, a financial advisor will ensure that your asset allocation will provide enough long-term growth to meet your goals. Finally, an experienced financial professional can help you make sense of what is happening in the economy and markets, as all too often the media can do more to confuse investors!
Investment adviser representative and registered representative of, and securities and investment advisory services offered through Voya Financial Advisors, Inc. (member SIPC).
Archstone Financial is not a subsidiary of nor controlled by Voya Financial Advisors.
1 https://www.cnbc.com/2020/06/27/us-coronavirus-cases-surge-by-more-than-45000-as-states-roll-back-reopenings.html
2 https://www.fool.com/knowledge-center/what-is-a-loss-on-paper.aspx
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