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Investor psychology can be fickle. Consider this common scenario: The stock market hits hard times, and nervous investors dump money and wait and see, thinking this is a “safer” way to weather the storm.
However, the math shows very convincingly that this is often the wrong strategy.
“In and out of the market, it’s a loser’s game,” said Lee Baker, a certified financial planner and founder of Apex Financial Services in Atlanta.
Why? Exiting during periods of volatility can cause investors to miss out on the market’s biggest trading days, thereby losing substantial gains.
Over the past 30 years, S&P 500 Index According to a recent analysis by Wells Fargo Investment Institute, stock index returns averaged 8% annually. The study found that investors who missed the market’s best 10 days during that period would have returned 5.26%, a much lower return.
Furthermore, if the 30 best days are missed, the average return drops to 1.83%. For investors who missed the market’s best 40 days, returns were worse, at 0.44%, or nearly the same, Wells Fargo said, while for investors who missed the market’s best 50 days, returns were worse. is -0.86%.
Those returns haven’t kept pace with the cost of living: From February 1, 1994, to January 31, 2024 (the period in question), inflation averaged 2.5%.
Markets change rapidly and unpredictably
In short: According to Wells Fargo’s report, the majority of the stock market’s gains were achieved “in just a few trading days.”
“Long-term misses on the market’s best days could significantly reduce the average annual returns that investors could earn by holding on to equity investments during the sell-off,” the report states.
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Unfortunately for investors, timing the market by staying invested during the up days and exiting before the losing days is nearly impossible.
Markets can react unpredictably and quickly to unknowable factors, such as the strength or weakness of monthly jobs reports or inflation data, or the outbreak of geopolitical conflicts or wars.
“Not only are markets difficult to predict, but when these swings occur, they happen quickly,” said Baker, a member of CNBC’s advisory board.
The best and worst days tend to “come together”
Part of what makes this problem so difficult is that the S&P 500’s best days tend to “cluster” during recessions. Wells Fargo said a bear market is when the market is “most volatile.” Some of the worst days occur during bull markets, periods when stocks continue to rise.
For example, Wells Fargo found that the 10 best trading days over the past three decades all occurred during recessions. (Six o’clock also coincides with a bear market.)
Some of the worst and best days came in quick succession: 3 of the 30 best days and 5 of the 30 worst days occurred between March 9 and March 18, 2020, according to Wells Fargo within 8 trading days.
“History shows that distinguishing the best and worst days can be quite difficult because they tend to occur within very tight time frames, sometimes even consecutive trading days,” the report states.
Experts say the math strongly supports people staying invested amid high volatility.
In and out of the market, it’s a loser’s game.
Lee Baker
Certified Financial Planner and Founder of Apex Financial Services in Atlanta
For further proof, just look at investors’ actual profits compared to the S&P 500 Index.
A DALBAR analysis cited by Wells Fargo shows that over the three decades from 1993 to 2022, the average return for stock fund investors was 6.81%, about three percentage points lower than the S&P 500’s average return of 9.65% during the same period.
This suggests that investors often guess incorrectly, resulting in lower profits for them.
“Frankly, the best advice is to strategically allocate across multiple asset classes and effectively stay the course,” Baker said.
