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The Panic Button
On September 18, the S&P 500 closed the day at 2,011.36. As of my writing (Oct. 16, 2014), the S&P 500 sits at 1,864.84. In other words, the S&P 500 has lost 7.3% of its value in less than a month.
Let’s put that in dollars and cents.
Let’s say that on September 18, I had $100,000 in my retirement account invested in a stock mutual fund that’s made up of something very similar to the S&P 500. This is pretty typical for people who are saving hard for their retirement.
Right now, that investment is only worth $92,715.38. $7,284.62 has vanished into thin air.
If you had $500,000 invested on September 18, $36,423.12 has vanished since then.
That kind of quick drop is scary to a lot of people. It’s not altogether different than the feeling you get when you’re riding a roller coaster and you start to drop off of a tall hill. It can make you feel a bit queasy if you think about it too much.
In the last few days, I’ve received a couple of messages from worried readers who have watched their retirement savings drop so quickly and have asked me if they should be doing anything.
My answer? No.
Stock Investments Are Long-Term Investments
First of all, as an individual investor, you shouldn’t have much money in stocks if you’re not investing for the long term. By long term, I mean 10 years at a minimum. If you plan on using money before the 10-year mark, it shouldn’t be invested in stocks.
Why is that? The biggest reason is that stocks are volatile. Over the short term – say, a year – stocks can gain a lot or lose a lot. If you’re invested broadly in the stock market (as most people are, in a mutual fund), you can have years where your investment goes up by 25% or drops by 40% (as in 2008). It’s really hard to predict which of those two it will be.
I like to use the typical person’s diet as an example of volatility. On some days, you’ll eat a big unhealthy meal or two and your calorie count for that day is really high. On other days, you’ll eat a small healthy breakfast, skip lunch, and eat a simple homemade dinner – your calorie count is really low that day. It’s volatile. Over the long term, though, the average is usually pretty sensible – but that doesn’t mean that every day or every week will be perfect.
That’s why you shouldn’t measure the success of your dietary choices based on your weight after one day or one week. Instead, you should look at a lot of measurements over a long period of time and the trend matters more than anything. A few measurements, particularly ones placed close together, aren’t too relevant.
The stock market is just like that. In the short term, stocks might dip – imagine your weight the morning after you eat low-sodium foods and drop some water weight – or they might shoot up – imagine your weight the evening after you eat two or three really heavy meals. Over the long run, though, they’ll average out to their long term trend, just like your weight.
Stocks Go Up Over the Long Term
Take a look at this chart. It shows the history of the S&P 500 since 1960. What you’ll notice is that, over that time frame, stock values are constantly going up (with some significant wobble).
How about this chart? Here, you can see the Dow Jones Industrial Average since 1900 – that’s more than 110 years of data. Imagine that – it looks an awful lot like the other chart, featuring a pretty constant upward trend (with some significant wobble).
Warren Buffett states that it’s realistic to expect a 7% average return from the stock market over the long haul.
What’s the point here? Stocks go up over the long term. As long as most Americans work – and they do – and as long as worker productivity keeps going up – and it does, practically like clockwork – companies will produce more and become more valuable, causing their stocks to inevitably rise in value over the long term.
Short-Term Dips Are Normal
Whenever people start selling off stocks, the price drops. That makes sense. If lots of people are selling, that means there are more sellers than buyers and thus in order to sell, the sellers have to drop that selling price. It’s no different than items that don’t sell at the store – eventually the price drops and they go on “clearance,” right?
There are all kinds of reasons for people to sell. Maybe the person needs cash for retirement. Maybe they’re just shifting their investments around. Sometimes, people sell because they see other people selling.
Eventually, though, someone is going to buy. Remember, stocks hold their value because of the future of those companies. If that company looks healthy for the next several years and is paying out dividends, that stock is going to always have at least some value. As the price drops, it’s eventually going to become a bargain.
When that happens, a lot of buyers come out of the woodwork to get that bargain. You can think of a stock market dip as being like a mild version of a Black Friday sale. People see bargains on those stocks, so they open up their wallets and buy.
This is why stock market dips always end and start rebounding. Eventually, the people who are selling run out of things to sell and the people buying “bargains” increases in number.
This type of “dip” happens very regularly. There are tiny dips on a daily basis. There are bigger dips – up to 10% of the value of the market – that happen over the course of a few weeks almost yearly. Every decade or so, there’s an even bigger dip – 20% or 30% or 40%.
At the end of those dips – every time in the history of American business – things rebound and the value goes back up to where it was before and beyond.
If You Sell Now, You’ll Lose Money (Unless You’re Insanely Lucky)
The only reason to sell stocks is either when you actually need the money or when your timeframe is getting short enough that you want your money in something less volatile.
If you try to “guess” the right time to sell to make a profit, you’re going to run into several factors that work against you every time.
First, you’re going to get hit with a tax bill on that sale. This is always true, but if you’re selling with the intent of buying later, some of the proceeds from your sale are going to vanish into Uncle Sam’s coffers, meaning you’re not going to be able to buy as much as you once have. (This doesn’t matter in a 401(k) because all of the taxes are deferred – as long as you keep the money in the account, you can buy and sell individual investments as you please.)
Second, you’re likely to miss out on some dividends. If you have your money out of the market for three months, you’re going to miss out on a dividend payment. If you’re out for a year, you’re going to miss out on several. That’s money you won’t receive.
Third, you’re probably missing the “top” of the market. That’s because you’re not psychic. No one is. If you sell right now, you already missed out on a hefty chunk of the drop.
Fourth, you’ll probably miss the “bottom” of the market when you buy back in. Again, that’s because you’re not psychic. No one is. Unless you guess perfectly, you’ll probably miss at least some of the rebound from the true bottom.
Finally, you may incur brokerage fees on both the “sell” and the “buy.” When you sell off your stocks, your brokerage will probably ding you with a fee. The same will likely happen whenever you buy back in. This also eats into whatever you gain.
In other words, if you time things perfectly and hit both the “top” and the “bottom” at the right moment, you might come out ahead – but you won’t come out as ahead as you thought. If you miss either the “top” (for selling) or the “bottom” (for buying), you’re running a healthy risk of losing money on the move.
Again, only sell stocks when you’re either cashing out for good or you’re moving to something with different volatility and long-term risk for good.
Just Sit Tight
It’s completely normal to worry a little when your stocks drop. The thing you should resist is the desire to make a move. If you do make a move, it’s very likely that you’re going to lose money compared to just sitting still and riding out the drop.
So just sit tight and don’t make a panicked move. You’ll be glad you did.