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How the Erratic 2021 Stock Market Rewards Smart Retirement Decisions
The stock market has seen ups and downs in 2020, to say the least. It took an enormous drop in the early spring, rallied throughout the summer, and appears to be dropping rapidly again in the fall, with all kinds of spikes and drops daily throughout.
For people who are in retirement and relying on their retirement savings, as well as anyone with significant retirement savings who is looking forward to retirement in the near future, that bumpy ride can create some real jitters. But should those jitters turn into action?
Paul LaMonica at CNN Business argues against panicking about these results. “What this comeback shows is that average investors who hold on to stocks for the long haul with goals like saving for a young kid’s college tuition, growing a nest egg to buy a bigger home or retiring should not panic when the market suffers a big slide,” he writes.
LaMonica’s point is that buying and holding onto stocks for the long haul is a great strategy, even during a bumpy year like 2020, and he identifies one good reason: the market will eventually rebound when things improve, and you want to be there for the rebound.
That’s just one reason for that strategy. Here are three more.
You don’t know where the peak of a stock market boom will be
Most people aren’t nervous about their stock investment when it’s going upwards at a healthy pace. That’s great, right? Everyone likes looking at their 401(k) when the balance goes up 15% each year.
The nervousness sets in when they see the balance dropping. They see a 10% or a 20% drop and that’s what gets them nervous.
Here’s the thing: by the time you’re nervous, most of the loss has already happened. Pulling out your investments at that point doesn’t prevent much further loss. It just ensures you won’t be collecting dividends, and it also ensures you won’t be there for some rebound.
Take a look at the stock market’s behavior in 2020. The stock market peaked in late February, then took a steep dive right at the end of February, before most people were even really aware of COVID-19 in the United States. After a brief rebound, the stock market started alternating days of very steep decline and days of sharp rebound that recovered some losses. At what point in that drop would you have decided was the right time to sell? If you chose to do so at any point after about March 10 — before much of anything was locking down in the United States — you would have already missed most of the spring stock market slump.
You don’t know where the bottom of a stock market fall will be
The reverse of the above principle is also true. When people see big returns in the stock market, they want to get on board and get some of those returns.
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The thing is, if you buy in after you’ve seen those big returns, you’ve already missed the boat there, too. You won’t get those big gains by buying in later. You only maximize your gains by having money in there when it hits the bottom, and if you wait around past that bottom to move money into stocks, you often miss a large portion of the rise.
If you couple this with missing the high point of the stock market, you are usually going to erase all the benefit of having done anything at all, and usually more than that.
This strategy of trying to guess when the peak of the market will happen and when the bottom will happen is called market timing, and it simply doesn’t work because we can’t predict the future.
Again, look at the 2020 stock market. It bottomed out on March 23. Would you have bought back in on March 23, with lockdowns coming into place across the United States? If not, you would have missed the huge rebounds that occurred over the next few days. Waiting literally just three days, until March 26, would mean you missed almost a third of the rebound. If you waited until April 9, you missed half of the rebound. It’s easy to see the bottom of the market when we look back on it, but at the time, March 23 didn’t seem like a hopeful date with a bright future ahead of it.
[ More: Is Early Retirement a Good Idea? ]
Your moves aren’t efficient
Making the problem even worse is that your financial moves within your retirement account aren’t usually very efficient. When you put in an order to sell your investments or buy new ones within that account, they typically don’t process until the end of the day, and sometimes it takes even longer than that. Waiting a day on the stock market can easily see a big gain or a big drop pass you by.
You can gain access to real-time trading platforms that have no commissions on stock trading, and usually only $0.65 per options trade. However, unless you’re a high-frequency day trader, your time is better spent focusing on saving money or investing in your retirement.
Furthermore, investment firms do mostly trade electronically, and a lot of that is steered by algorithms, which react almost instantaneously to changes in the stock market. Even people with real-time trading platforms can’t react with the speed of a computer algorithm.
The solution is to diversify, invest automatically and ride the ups and downs
What’s the best solution to all of this? The consensus of many stock market experts is to simply diversify as widely and inexpensively as possible and just sit on it, through thick and thin, only making moves related to upcoming needs in your life.
The easiest way to do this is to buy index funds within your retirement account. Index funds are large collections of stocks with very low fees, usually because they’re automated or nearly automated — they buy everything within their description so that you own a slice of the whole pie. For example, the Vanguard Total Stock Market Index, one popular index fund, buys small amounts of every publicly traded American company. Because of those simple rules, the fees on most index funds are super low, so you mostly just ride the ups and downs of the whole stock market. Target retirement funds are a similar option, as they’re usually just collections of index funds of different types of investments — stocks, bonds, cash and more.
As you’re riding through the waves, just keep buying in regularly through automatic deductions from your paycheck or checking account.