Here are the three things you need to coax yourself back into the stock market if you are on the sidelines. Plus, why short-term market declines are difficult to accurately predict but bear market declines can often be anticipated and avoided.
In this episode you’ll learn:
- Why moving back into the stock market after being on the sidelines is not just a tactical decision, but an emotional one.
- What is the law of large numbers.
- How often does the market decline.
- Why bear markets typically accompany recessions.
- Why short-term market declines are extremely difficult to avoid, while bear market declines can be successfully anticipated and managed around.
How To Reenter the Stock Market
I recently received an email from Josh who asked a question I get frequently. Josh’s portfolio is primarily in cash. “On the sidelines,” is how he put it. He wants to know how to move back into the stock market after having been out for awhile.
More specifically, he is waiting for another 10% decline in stocks before “pulling the trigger” and moving back into the market.
About a week before Josh’s email, I received one from another listener of my podcast who had essentially the same question. He wrote he had stayed away from the market because he feared entering at the wrong time. But he also acknowledged he couldn’t wait for the right time to invest otherwise the cash in his account would gradually lose value due to inflation.
In early 2009, I was hired by a foundation for an environmental organization. They had sold stocks and moved millions of dollars into cash in late 2008. They were fearful and could no longer stand the losses. The future was so uncertain. They hired me in part to answer the same question these listeners had.
How do you move back into the market when there is a chance the market will fall further and if it does you will look stupid and feel bad?
Notice this is not merely a tactical question. This is an emotional question, laden with fear and regret.
The Odds of Success
The reality is moving completely out of the stock market and then back in will more than likely result in a mistake along the way, most likely in timing.
Investors who are 70% successful in timing their shifts out of the market and 70% successful in moving back in at the proper time still have less than a 50% chance of getting both decisions correct.
Trying to time short-term movements in the stock market is nearly impossible. Since 1928, U.S. stocks as measured by the S&P 500 Index have fallen more than 5% on average 3.4 times per year with an average decline of 10.9% according to data from Ned Davis Research. These losses lasted on average for 36 days.
So on average the market falls more than 5% every 15 weeks with those losses occurring on average over a month’s time. That is known as market volatility.
Consequently, a reasonable assumption when you move back into the stock market after being out for a period of time is the market will probably go down in the near-term.
Not A Mistake
If the market falls, will you feel bad? Yes. Is it a mistake? No. Holding yourself accountable for something completely unpredictable and out of your control is foolish.
If you decide to get married during the winter months in Seattle there is a greater than 50% chance it will rain on your wedding day. Will you feel bad if it rains? Probably. Is it a mistake? No.
Of course, you could play the percentages and get married in July when there is only a 16% chance it will rain on your wedding day.
Likewise, you could play the percentages in terms of shifting back into the stock market. The best month for reentry into the U.S. stock market is November according to data from Ned Davis Research.
Since 1952, the U.S. stock market as measured by the S&P 500 Index has gained 3.9% on average for the three months from November to January and 6.8% on average for the six month from November to April.
The worst time historically to reenter the stock market is the summer months. The average six month gain for the S&P 500 Index from May to October is 1.5%. For the three months from August to October, the S&P 500 Index has lost -0.1% on average.
Hence, it is better to get married in the summer and reenter the stock market in the winter.
Focus on the Long-term
A more prudent approach than trying to time the month of reentry into the stock market is to set a long-term plan. That is what I did with my foundation client.
We segregated their funds into those assets they needed to draw on in the near-term from those that were long-term in nature. Then we developed an asset allocation plan for each portfolio bucket based on reasonable rates of return over the subsequent ten years.
Refocusing on the long-term allowed this client to stop focusing on short-term fears. The client reentered the market in stages over the following six months and was able to rebuild their asset base by participating in the market rebound.
Having a long-term asset allocation plan and recognizing that predicting short-term stock market movements is impossible can help convince investors who are on the sidelines to move back into the market.