In case you haven’t been paying attention (and good for you if you haven’t!), the past month has seen some large moves in equity markets and bond markets. The market started falling about a month ago and bottomed out at a loss of 4 percent on June 6, only to quickly recover this week. I know that choppy markets correlate with rising anxiety, so it’s not surprising we’ve received more questions than usual about what you should do.
Our answer is easy: Don’t change a thing.
I’m very happy to see that a full 98.7 percent of Betterment customers didn’t blink. No withdrawals, no reductions in risk. That’s the right thing to do, especially when markets get choppy. It’s very easy to turn a large investment account into a small one by reacting emotionally to market movements. The steadfastness we’ve seen the past month makes us proud.
Even so, it’s hard not to feel nervous when the markets bounce around like they did the past month. But evidence shows that it’s all too easy to let bad feelings translate into poor investing. The next time markets are turbulent, keep these lessons in mind:
Lesson 1: Recent declines DO NOT predict future declines!
If only predicting stock market movements was as easy as seeing what it did last month. Betting that one month of bad returns will be followed by another is a losing strategy, to the tune of about 6.9 percent, on average.
The graph below plots the S&P 500 returns for every month going back to 1950, broken up by whether the previous month was a gain or a loss. As you can see, while there is more variation after a down month (in both directions), the average annualized return for a month following a losing month was 6.9 percent. Those are gains you could miss out on if you are not in the market.
Monthly returns after market gains or losses in the S&P 500 since 1950:
Lesson 2: Pre-act, don’t re-act
One of the things soccer goalies learn early on is that to block shots, they must focus on where the ball will be, not where it is now. In other words, pre-act, don’t re-act. Reacting to market movements is like jumping after a goal has been scored – you won’t undo the damage that’s already done. But unlike soccer, you’re likely to cause even more damage by jumping after the fact, since you’ll miss out on the recovery.
But not reacting can be very stressful and hard to master. Studies have shown that goalies would block more shots by staying still, rather than jumping around. However, the problem is that goalies fear they’ll later end up regretting that they “did nothing” and their emotions compel them to dive more than they should (often away from the ball).
Lesson 3: Taxes. Taxes! TAXES!
You might not know this, but the government actually wants you to be a long-term investor. The tax code is designed to give you a strong incentive to do so. Generally, short-term capital gains (those arising from investments held less than a year) are taxed at your marginal income tax rate. But if you hold investments for a year or more, those gains are taxed at a rate that works out to be lower for the majority of investors (15 percent for most investors, but could vary, depending on your income bracket).
So even if you think you are “banking your gains” now by selling securities you’ve held for less than a year, the IRS could be happily banking up to 39.6 percent of those gains as well. Eventually, that gain will get taxed, but likely at a significantly lower rate if you just wait out the storm.
Lesson 4: Cashing out means deciding when to get back in
One of the most subtle problems of cashing out after a market fall is figuring out when to get back in, and then actually pulling the trigger. After the crash in 2008, many investors waited too long to get back into the markets. As a result, they had the losses, but not the subsequent gains. It’s scary to get back into markets after a loss, so investors often spend long periods sitting on the sidelines. The result? You’ve sold low and bought high. That is exactly the opposite of a winning strategy.
How does all this relate to the way you should be investing?
For short-term goals, it might mean making a one-off deposit to your account or saving a little bit more to get back on track. In the short run, saving is the surest way to reach your goals. For long-term goals, log in to Betterment and check your advice tab. Odds are very good that this bump in the road hasn’t affected the likelihood of achieving your goals at all, since subsequent market recoveries will dilute away the loss.
It can be counterintuitive, but it’s actually very simple: With investing, you do better by doing less. Still, we realize that falls in the value of your account can be very stressful, so if you would like to to speak with me, or with any of our other investment experts, please get in touch. We always love hearing from you. You can reach me at firstname.lastname@example.org.
Keep investing better.
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This article was published on June 19, 2013