The markets have gotten off to a rough start in 2022, giving investors the equivalent of a nasty New Year’s Eve hangover.
So perhaps this is a good time to remind everyone that market pullbacks are normal occurrences, taking place about once per year on average. Nonetheless, absolutely no one enjoys the stress and anxiety they can create.
It’s hard not to react emotionally to scary news, but it’s important to stay calm and think rationally. Making impulsive investment decisions based on short-term events can permanently harm your portfolio.
There are several ongoing developments the market needs to digest. Gradually rising interest rates and inflation are at the top of that list. Tight labor conditions, supply chain shortages, and of course COVID aren’t far behind. Fast-growing tech companies were among the hardest hit in the downturn, although companies in the broader Dow Jones and S&P 500 indexes dropped as well.
Pullbacks are normal
Pullbacks are dips of 5% to 10% from a recent market high. They are usually short-term, lasting a month or so on the downside and another month for markets to regain previous price levels. A more serious market correction involves a drop of between 10% and 20% and occurs about every two to three years. Stocks fall for 4 months on average, then regain lost ground. Only 20% of corrections since 1974 have led to a true bear market. Financial markets often recover from downturns during the year to close in positive territory by year-end, and even mark new highs. Since 2000, pullbacks of 10% or more occurred in more than half of all years. That certainly did not stop the market from climbing impressively upward over that time span.
It’s not what the market does, it’s how you react
How investors react to events can make the difference between ultimately reaching their financial goals or falling far short. Here’s why:
Most people are programmed to react emotionally to negative (or positive) market events. It’s hard not to; it’s been hard-wired into our brains as part of a fight-or-flight impulse ever since we struggled for survival in prehistoric times.
Unfortunately, once they cave to that emotional impulse, they’ve sealed their fate. They risk turning a temporary loss into a permanent one.
Behavioral finance expert Jay Mooreland, author of “The Emotional Investor,” explains the difference between temporary and permanent losses.
Temporary losses are both normal and expected. They occur each time the markets experience a pullback, and as we know, markets routinely go up and down. That’s just part of a normal cycle. Pullbacks are temporary in nature, and may last a few days, a few months, or even longer in the case of a true recession.
But historically, market prices rebound after the pullback, and typically continue to climb to new highs. That’s happened after each correction and recession in modern American financial history, including the Great Depression and the 2008 financial meltdown. Pullbacks drive down prices, says Mooreland, and these “temporary losses create fantastic opportunities for investors.”
But if nervous investors use pullbacks to sell, not buy, they permanently lock in losses, and may never recover. Emotional investor behavior, not declining markets, is “the primary reason permanent losses occur,” explains Mooreland.
And while we have no crystal ball, the evidence we’ve seen to date does not seem to point to a recession. It points to a market facing several uncertainties that will probably struggle before finding new footing. There will undoubtedly be more rocky days ahead, but keep in mind that for long-term investors – especially those investing for a decades long retirement horizon – the losses we see will be temporary ones. Those losses can only become permanent if you lock them in by selling.
Seasoned investors know not to react too quickly when markets get volatile. There’s often no real news that justifies these sudden price dislocations, but it’s always prudent to pause for a moment, re-evaluate market conditions, and make course adjustments as necessary. For months, we’ve expected interest rates to climb higher as the economy reverts to “normalcy” after the onset of the COVID pandemic and the Fed’s extreme monetary easing. The economy should be strong enough to take these rate hikes in stride, and promising companies with solid earnings, growth prospects, and strong balance sheets should do the same.
What may need some adjustment is public expectations that markets go up, up, up without a hiccup or two. That’s just not realistic.
Our strategy for client portfolios? We recommend you stay invested, stay diversified, stick to the allocation, take moderate profits, and control what you can – namely, your spending and your retirement savings. There is no investment “magic wand” that can salvage your retirement if you spend too much and save too little. That’s why we’re so proud to see our savvy clients keep an eye on saving and spending to help ensure a sustainable financial future.
On the investment front, we still like the dynamic technology sector, but this is a good reminder not to chase performance or “put all your eggs in one basket.” As noted on previous occasions, better bargains can be found elsewhere, like among non-U.S., value and quality dividend-paying stocks, small-cap companies, and others. Our job is to help you reach your long-term goals and make your money last as long as it needs to. That means making intelligent decisions and smart tradeoffs between potential risk and return in a constantly changing market environment.