Imagine it’s Jan. 1, 2008, and you’ve just put your savings into the SPDR S&P 500 ETF Trust (NYSEMKT: SPY). The financial crisis hasn’t fully turned into a disaster, but the signs are building. Subprime mortgage funds are imploding, and Bear Stearns will fail altogether in about two months. The benchmark S&P 500 (SNPINDEX: ^GSPC) is about 9% below its high, but investors aren’t in panic mode yet.
By the end of the year, your investment has lost nearly 40% of its value. The bottom won’t come until March 2009, with the S&P 500 down more than 50%.
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What would you have done in that situation? Would you have sold along the way? Would you have ridden it out to the bottom and back?
Warren Buffett would have held on. In fact, he’d probably have been shopping for bargains around that time. As stock prices kept falling, his decision to hold probably would’ve looked like a mistake. History, however, shows it would have been the right decision.
The investor who did nothing came out ahead
The problem with trying to time the market or making an emotional decision to sell during volatile markets is that you have to be right twice to make it work. You have to get out before the bottom is in, and you have to buy back at a price lower than where you sold.
In reality, most investors don’t have the stomach to buy when conditions are at their worst. They’ll say that they’ll “wait until things get better” before getting back in. The problem with that is that stocks usually start rebounding long before conditions “get better.” The true buying opportunities get missed. Investors lock in the losses and miss out on the gains during the recovery. This is what damages long-term returns.
Once they feel like conditions have gotten better, a lot of people soon realize that stock prices have already rebounded. How many times have you heard someone say “What’s the point, I’ve already missed out” and use that as a reason to avoid returning to stocks altogether? Now they’re missing out on additional future returns because their investment strategy has broken.
And let’s not forget that no one can see the future. You’ll never know what the right time is to get out, the right time to get back in, or what might happen in between.
That’s why Warren Buffett’s strategy of essentially doing nothing but investing regularly is so effective. Investing is one of the few things where doing less is actually doing more. You avoid the emotional decision making, you focus on your long-term goals instead of short-term noise, and usually end up coming out better for it.
