Don't Overreact
Behaviors to Avoid
The one thing that is certain about the market is that it goes up and down. It sometimes does this quite erratically. This fact has been true since the conception of the modern equity markets in 1926.
When caught in one of these sudden movements of the market it is very hard to maintain your sense of perspective. Imagine that you had invested $50,000 in the S&P 500 Index beginning in 1995. The graph below shows how market changes would have affected your balance. The mid- to late-nineties stock market boom, which peaked in March of 2000, would have boosted your investment to almost $150,000. The correction that followed over the next two years, however, would have reduced your balance to $84,000. That is a loss of $66,000 in just 2 years. How would you have reacted? Would you have moved your money to less risky investments?
Let’s see what would have happened if you kept your $84,000 fully invested in the market. Between 2002 and 2007 the market rebounded. Fully invested, your $84,000 balance would have grown to $172,000, an increase of $88,000 and $122,000 more than your original investment of $50,000 in 1995. The lesson to remember is that if you had moved into less risky investments and gotten out of the stock market following your losses in 2002, you almost definitely would have missed much of the $88,000 in gains that followed and your balance would have been significantly lower by 2007.
It can be very difficult to remain calm and maintain your investment strategy when your account balance is decreasing with each statement. History has shown, however, that over time stock market losses tend to be made up by gains for long-term investors who choose investments that are appropriate for their goals and stick with them. It’s time in the market, not timing the market, which leads to success.
This brings us to the present. Following that same $50,000 investment from 1995, the market correction that began in 2007 would place your investment at about $147,000 as of June 30, 2008. Your statements would have reflected a drop of over $22,000 between mid-2007 and June of 2008. Would you get out of the market and risk missing future returns, or would you hold on to your investments to catch the gains when economic circumstances change? Developing a portfolio that matches your ability to tolerate rises and falls in the market can be a major factor in your investing success.
Decide for yourself how much risk you can tolerate and develop a portfolio that matches your risk tolerance. To learn more about developing a portfolio based upon risk use ICMA-RC’s Guide to Selecting the Right Portfolio or take advantage of the services offered through ICMARC's Guided Pathways® program.
More information about the risks of overreacting to short-term market changes and the benefits of investing with a longterm focus are available on the following pages:
- The Cost of Losing the 10 Best Days of the S&P 500 Index
- Reduction of Risk Over Time
- S&P 500 Index Historic Calendar Year Returns 1926-2007
This illustration was compiled by information from outside sources. These companies are not affiliated with ICMA-RC. This information is being provided for educational purposes and is not intended to be construed as or relied upon as investment advice. ICMA-RC does not offer specific tax or legal advice. Individuals are advised to consider any new investment strategies carefully prior to implementing.
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