Why you Shouldn’t Pull out of the Market in Tough Times

A colleague and subscriber to 20somethingfinance recently asked me if there’s anything he should be doing with his 401K investments in light of the horrific market returns of late. Admittedly, it can be very discouraging to see your hard earned money dwindle with seemingly every passing day, however, one of the traits that leads to investing success is learning how to stomach the inevitable bad times.

Pulling out when times get rough tends to be a common thought that crosses the minds of many new investors. Fear sets in, and the thought is that maybe it would be best to get out now and wait for the good times to return and then jump back in. Another common malpractice is to switch from riskier stock based investments to more stable bond or interest bearing accounts. At a young age, both strategies can lead to underperforming the market. Here is why:

1. Market Timing is Rarely Effective

Trying to time jumping in and out of the market is like betting against the house. The odds are not in your favor. As Joe Amateur investor, your view of the market as a whole is based on hearsay from common knowledge that is probably already built into the value of your investments. For you to take action on something that everyone else knows means you are a late mover in the game, and late movers almost always get burned in the investment world.

2. Market Buying Opportunities Will Present Themselves

History has proven time after time that when negativity in the market reaches it’s peak, prices are going to hit their lowest and then begin to bounce back with time. When you actually feel like pulling your money out the most, you will find that it may be the best time to buy. I know it sounds counter-intuitive, but just think about it for a moment – a good company or fund is probably still good despite having its value sink due to widespread general market pessimism. Do you want to buy those good investments when they are at their high price peaks during optimistic times, or when they are on sale at their low points during times of high pessimism?

3. Age Heals all Wounds

If you are near retirement, then trying to tough out a huge market downturn is probably not going to serve you well, especially if you are in higher risk investments. By this stage in life, you should have moved the majority of your investments over to high yield, low-risk options that aren’t as prone to taking a big hit from macroeconomic movements. When you’re in your 20’s you have a lot of years ahead of you and if you pull your money out to avoid the downturns, you’re most likely going to be sitting on the sidelines, missing the upturns.

4. Stock Market History Usually Repeats Itself

As mentioned in previous posts, the average annualized rate of return for U.S. stocks was 13.4% from 1926 to 2000. The worst average annual rate of return for U.S. stocks in any 65 consecutive year period has been 8.5%. In light of those historical results, pulling out when you’ve already taken a hit and sitting on the sidelines for the rebound is poor strategy.

Have you been burned trying to time the market? Tell us about your lessons learned.

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