The experience of a declining market or perceived recession can be a heart racing experience. The temptation to move investments to historically safer territory can be overwhelming.
But history tells us that sticking with your long-term investment plan, including higher-risk equity positions, may give you something you wouldn’t have standing on the sidelines – a better opportunity to take advantage of the markets’ recovery.
We say perceived recession because economists don’t agree on a single definition, and usually can’t be certain one occurred until well after the fact.
Since World War II, the United States has witnessed approximately 10 recessions by the classic definition, lasting anywhere from six to 16 months and varying in severity. The classic definition of a recession is a decline in Gross Domestic Product (GDP) for two or more consecutive quarters.
Today, many economists go further, taking a range of economic data into account. The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) provides a comprehensive determination by factoring in measurements such as employment, industrial production, real income and wholesale-retail sales.
Still, because any definition requires backward-looking measurements, the stock market usually begins reacting to recessionary pressures well before anyone can be certain that a recession is taking place. This makes timing the bottom of the market extremely difficult.
Looking back at the most recent recession, the S&P 500 experienced three straight years of negative performance (2000-2002) before rebounding with five consecutive years of positive results (2003-2007). While past performance offers us no guarantees for the future, historically, some of the most dramatic market gains have followed market lows or while coming out of
Even though recessions and market corrections are separate and independent events, the pattern of decline and recovery are similar. The returns after a recession or a correction have historically exceeded the long-term market average by a wide margin.
Yet missing just a few choice days in the history of the market cycle by swaying from a disciplined investment plan can make a huge difference in the returns investors realize. Getting out of the market is not the difficulty; it is the potential penalty for not choosing the right time to get back in. If an investor were to miss the best 10 days in the market over the last 20 years, their average annualized return drops from 11.82% to 9.17%. Missing the 30 best days during the same period drops the return to 5.26%, a potentially crippling blow to a retirement plan.
While no one can predict the bottom of the market, history shows that the U.S. economy is resilient, and that rebounds can take place quickly. Missing just a few of the leading rebound days can make a significant difference in the longterm performance of a portfolio. The only way to be assured of capturing all of the market upside is to remain fully invested, using a long-term investment plan with a portfolio diversified over several asset classes and investment styles.
While sticking with your investment strategy through turbulent markets can be a nerve-wracking experience, history suggests you may benefit by hanging on.