Though the stock market is flying high at the moment, some investors have not forgotten the market downturns.
However, many of the market declines of the last decade, including the stock market crash of 2008, are becoming faded memories. But investors who endured these difficult times, and stayed invested, came out in great shape.
That's because, after every decline, no matter how severe, investors tend to recover their losses, and markets tend to stabilize and see positive growth. The same can't be said for investors who sell into market downturns hoping to stem their losses. Here are three reasons not to sell after a market downturn.
1. Downturns Tend to be Followed by Upturns
In down markets, investors are often overcome by their "loss aversion" instincts, thinking that if they don't sell, they stand to lose more money. However, the decline of the asset's value is often temporary and will go back up.
On the other hand, if the investor sells when the market is down, he or she will realize a loss. A lesson many investors have learned is that even though it can be challenging to watch a declining market—and not pull out—it is worth it to sit tight and wait for the upturn after.
Research has shown that the average duration of a bear market is less than one-fifth of the average bull market, and while the average decline of a bear market is 28 percent, the average gain of a bull market is over 128 percent. The key takeaway is that a bear market is only temporary, and the next bull market erases its declines, which then extends the gains of the previous bull market. The bigger risk for investors is not the next 28 percent decline in the market, but missing out on the next 100 percent gain in the market.
2. You Can't Time the Market
Timing the market can be incredibly difficult, and investors who engage in market timing invariably miss some of the best days of the market. Historically, six of the ten best days in the market occur within two weeks of the ten worst days.
This indicates that if an investor sells during downturns in the market, he or she will likely miss the highest upturns. According to JP Morgan's Guide to Retirement 2016, an investor with $10,000 in the S&P 500 index who stayed fully invested between January 2, 1996 and December 31, 2015, would have more than $48,000. An investor who missed 10 of the best days in the market each year would have only $24,070. A very skittish investor who missed 30 of the best days, would have less than what he or she started with—$9,907, to be exact.
3. It's Not Part of the Plan
An investor who has a well-conceived, long-term investment strategy should not be overly concerned with the short-term movements of the market.
For someone with a 20-year investment time frame, the stock market crash of 2008 or the market downturn after the Brexit vote is likely to have a smaller effect on the long-term performance of his portfolio, compared to someone who sells off during the downturns.
What is important to a long-term investor is his own investment goals and a sound investment strategy based on a well-diversified portfolio with a mix of asset classes that keep volatility in check. To have patience and the discipline to stick with the strategy is highly important to successfully manage a portfolio, and an investor who has conviction in a long-term investment strategy is far less likely to follow the panicking herd over the cliff.