Stock Declines Are a Pretty Normal Part of Investing - And What We Should Do About It
Death, taxes, and (temporary) stock market declines—some things are just part of life.
Lately, headlines have been buzzing with drama: government policy, economic concerns, tariffs, and stock market fluctuations. There's been plenty of fodder for publications vying for your attention.
It's been a rocky start to the year for the stock portion of your investments. From their February highs through March 14th:
- The US stock market declined ~9%
- The global stock market declined ~5% (Diversification for the win! 🌍)
As of writing, both are positive year to date. Nothing crazy, but after a few years of strong positive returns, even minor bumps can cause a bit of rattling in the nerves.
The Big Question: Where Will Market Prices Go From Here?
I don't know.
You don't know.
Nobody knows 🤷♂️.
What we do know is that stock market declines are quite common and happen with surprising regularity. It's an expected part of investing.
So… what should we do when markets slide?
Let’s talk about what history shows us—and what smart investors (like you) can do in response.
Stock Declines Are a Pretty Normal Part of Investing
Let's look back at the US stock market, as there's quite a lot of data to learn from.
We've seen declines of 10% (or more) with consistency over the years. Depending on the year you start with, we've seen the US stock market produce declines of:
Over the last 45 years, we saw that:
- Average annual return: ~12%
- Positive years: 35 out of 45 (78%)
- Average yearly decline: 14%
Think about that. To achieve long-term average returns, you had to put up with an average decline within each year of ~14% - even if the year ended positive. A double digit decline would be considered "typical".
Of course, there's a wide range of ups and downs to get the average numbers. But that's what we should expect when investing in the broad collection of corporations in the US and all over the world.
The Temptation to Sell (And Why You Shouldn't)
Many investors feel the urge to take action when markets decline. This might be the single worst decision at the worst possible time.
What we see historically - and woul.d expect - is that (on average) returns are positive after stock declines. And there is a long history of stock market ups and downs, of different shapes, lengths, and sizes.
We never know how deep they'll go, or how long declines will last - that's the uncertainty we accept.
But historical data tells us that poor returns tend to be followed by positive returns.
Businesses continue to operate to sell their products and services and earn profits for you, the shareholder. You are able to buy all of these businesses and their future cash flows at lower prices.
Each situation is different - the details and causes are always different - but they've historically tended to end about the same.
For those that are regularly investing and adding to your accounts, this is an opportunity to buy the stuff you want to own for decades on sale.
If we're going to experience the risk, we might as well stick around for the eventual reward.
Markets Have Rewarded Discipline
Throughout history, we've seen events that could discourage investing. Sometimes, quite dramatic and scary events:
- Two World Wars and a Great Depression
- Global conflicts
- Economic shocks
- Terrorist attacks
- The Great Recession - a near meltdown of the global financial system
- A global pandemic
Yet, markets have consistently rewarded long-term, patient investors.
Of course, the past isn't guaranteed to happen in the future. The future is always uncertain - that's the nature of investing. But history is a fantastic way to get reasonable expectations.
What we've seen is that declines are a normal part of the experience when investing in businesses all over the world.
That short-term risk and uncertainty is the price we pay - the price of admission - for the higher longer-term returns of the stock market over more stable investments.
As the saying goes, "no pain, no premium."
Regardless of the circumstances, we expect the best corporations of the world to continue working to earn a profit.
Actions To Take During Declines
So, what should we do during market declines? Here are some things I'm doing as I monitor client investments.
1. Don't Try to Time the Market
Market swings each day, month, and even year are incredibly unpredictable. Daily swings can play games with your mind.
Take COVID for example. During any decline, its tempting to say "let's sell now and get back in at the bottom".
The whole decline lasted about a month - it happened quickly and then ended more quickly than others before.
And the daily ups and downs were a sight to behold. Here's just a snippet of consecutive trading days:
From March 12th - 16th, we saw (one after another):
- A double-digit decline
- The best (tied) daily return
- The worst daily decline
There's no conceivable expectation of making two separate decisions exactly right - timing the right time to sell and the right time to buy. And all while also having the mental conviction to actually follow through on it when things are moving like that.
And there is a pretty substantial cost to not being investing and missing out on just a few of the best days of returns.
Unfortunately, I've seen first hand when people sell and never actually reinvest the dollars, even years later - always looking for that opportunity. We can only look back at the dollars lost while sitting in cash.
2. Remember Your Time Horizon and Check Your Mix of Investments
Remember the goal you're investing toward, and how long you'll be invested before you'll actually need the money.
Investing isn't done in a vacuum - your money is a tool to be used toward some future goal. What are we planning for? And are you invested in the right mix of investments for that goal?
If you're investing toward long-term financial independence, you'll be invested for the next several decades of your life.
The longer your time horizon, the more reliably positive stock market returns have (historically) become.
The chart below shows range of returns for the US stock market (blue) and a mix of the global stock market (green) - from shorter periods of time (left) to longer (right)
In the short term, there's a very wide range of outcomes - both positive and negative.
As we lengthen the time horizon - 5 years, 10 years, 15 years and beyond - we see that over long term periods the range of outcomes is much tighter and typically positive.
Interestingly, in this date range there have been no periods of 15 years or longer that were negative!
Of course, the future is uncertain. There can always be events we've never seen unfold. But, again, history helps us set reasonable expectations.
The thoughtfulness on the right mix of stocks, bonds, and other assets that makes sense for your life and investment goals helps us to be prepared no matter then stage of life you're in. This may be a great time to reevaluate that.
Longer time horizon goals (e.g., financial independence) need to be invested and planned for much differently than shorter-term goals (e.g. house down payment).
And broad diversification helps us to manage the risks of one business - or a few - failing during tough times. Global diversification aims to do the same, against long, drawn out issues unique to one country, currency, or economy.
3. Rebalancing Thoughtfully
With client investments, I look for opportunities to rebalance - trim the categories of your investments that are much higher than we're targeting, and adding those dollars back to the categories that are too low.
This helps us to keep within the range of risk and return we are aiming for. And it's a sneaky way to sell "high" and buy "low" on a set system without emotion.
4. Tax Loss Harvesting
For taxable (non-retirement) accounts, if you've recently invested dollars and the funds decline for a loss, it may make sense to sell those funds and immediately reinvest them into something else.
This is a tax planning opportunity - those capital losses can be used to offset other capital gains, and up to $3,000 can be deducted against your other income.
It doesn't make sense for everyone, but it's a nice planning benefit when it does.
5. Roth Conversion
In years where we already know it will make sense to do Roth conversions from a tax standpoint, a decline is a great time to do them.
When prices decline, we can convert the same amount of dollars but more shares. That means more shares of the funds we own grow tax-free in the Roth account.
6. Do Nothing and Enjoy Life
Other than that, the very best action is often to do nothing.
Go for a walk, have a cup of coffee. Turn off the TV, and enjoy life.
Stick with the long-term investment plan you put together, along with the actual goal you're planning for. Our best advantage as long-term investors is our patience and willingness to stay invested when others are fearful.
If you don't have a clear plan, or if you'd like to chat about your own investments - reach out.
Have a great week!
New From our Education Hub
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Ep. 130: Are Stock Market Declines Normal?
I dive into the same topic in greater detail, going through what history tells us about stock market declines, and action we should take in light of that.
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