While the global pandemic and economic shutdown resulted in a sharp economic downturn and bear market, the stock market has been able to recover quickly. With the benefit of hindsight, this is because most investors and economists see a light at the end of the tunnel. Although the public health crisis is not yet over, businesses in many parts of the country have been able to slowly reopen, allowing corporate profits to recover.
Keeping Investment Composure Is Critical
In this way, the first half of 2020 has been an important reminder that it’s often darkest before the dawn. History repeatedly shows that investors should keep their composure and stay invested, especially when the overall market is uncertain. This is true whether investors are worried about COVID-19, trade wars, elections, geopolitics, the Fed, and many more issues. While it is difficult to watch the stock market fluctuate wildly on a daily or weekly basis, this is often the right thing to do over months, years and decades. There are a couple of reasons for this:
Stocks Can’t Be Predicted
First, a half-century of financial research has shown that the stock market is difficult and maybe impossible to predict in the short run. While we can often find explanations for market behavior in hindsight, our best guesses of where the market will head in the upcoming days and weeks are often wrong.
This is because financial markets are forward-looking. So even though the coronavirus crisis continues, stock prices are already anticipating what will happen once the economy is fully reopened. This goes hand in hand with how the U.S. stock market has behaved in the long run: it tends to rise alongside economic growth.
Chart: The S&P 500 index is now back to its starting level for the year, and is only a few percentage points from its pre-crisis peak. This chart shows the performance of the S&P 500 using three different starting points.
Selling in a Panic Leads to Losses
Second, even if stocks were predictable, investors are often tempted to react to short-term news by holding too much cash. While having enough cash on hand to pay the bills is an important part of personal financial management, selling one’s investments out of fear is a different story. Not only does the stock market often recover when investors least expect it, but cash generates no long-term growth for portfolios.
Ultimately, it’s important for investors to feel comfortable with their investments. After all, financial returns are only one part of the picture – being able to sleep well at night matters too. The challenge of investing is to strike a balance between short-term risk and long-term gains that can help make achieving financial goals a reality.
Holding a Diversified Mix of Assets Helps Investors Stay Composed
Thus, rather than over-reacting to short-term market events, it’s often better to hold a mix of assets that can help investors to stay the course. Today, with numerous stock and bond ETFs at investors’ disposal, it’s easier than ever for investors to build a portfolio that they can stick with through thick and thin.