Stock market declines are unfortunately inevitable. And while no one likes to see their portfolio value drop, dips can actually be good for many people and healthy for the stock market.
With the stock market currently in a bear market, there are at least two potential winners and one potential loser, and I’m not talking about individual stocks. Let me explain.
Winners: people who have time on their side
Time can be a powerful force in investing. Not only does this fuel compound interest, but it also gives you time to recover from inevitable market downturns. Not all businesses will survive market downturns, but it is almost certain that the main indexes and blue chip stocks will be. Past performance does not guarantee future performance, but it is a very good indicator.
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The S&P500 is used by many as an overall indicator of stock market performance. Even during some of the worst economic times in US history – like Black Monday (1987), the Dot Bubble (2000-01), the Great Recession (2008-09), and the COVID-19 pandemic (2020 ) — it’s been successful in delivering solid returns, IF you look at it over the long term. The same goes for the Dow Jones Industrial Average and the Nasdaq Compound.
There’s a reason conventional wisdom tells you to become more careful with your investments as you approach retirement: you have much less time to recover if something goes wrong. If time is on your side, you can take on riskier and more rewarding investments to focus on growing your money instead of just preserving it.
Winners: people who cost on average
If you’re not careful, you may find yourself trying to wait for the “bottom” of a market pullback before you continue (or start) investing. After all, why invest now when you can get the same stocks cheaper later, right? Not enough.
Even if you manage to time the market once, it is nearly impossible to do so consistently over the long term and sets a bad precedent. Instead of trying to time the market — and risk being the shortest of the stick — investors should use purchase average.
Averaging occurs when an investor makes regular investments on a set schedule, regardless of how the stock or the overall market is doing. Good stocks rising? Invest. Do good deeds seem to be in freefall? Invest. Do good deeds remain stagnant? Invest. By sticking to a schedule and investing no matter what in the companies you believe in, you can keep yourself from trying to time the market.
Using dollar cost averaging during market downturns is also a great way to potentially lower your cost base, which determines how much you gain (or lose) when you sell your stocks. Your cost base is the average price per share you paid for a share, so the lower the better.
Losers: Panic sellers are losing right now
Panic selling occurs when an investor sees stock prices falling and decides to sell their shares prematurely to cut their current losses or take profits before the price drops. Panic selling is almost never the right decision. Not only can it hurt you in the present, but it can affect your financial future.
If you benefit from panic sale, you will also need to consider tax implications. If you have held the investment for less than a year, the profits will be taxed at your usual tax rate. But if you’ve held it for more than a year, it will be taxed at your capital gains rate. Aside from taxes, these are also stocks you never gave the chance to rebound and potentially produce better long-term returns.
You never want to make short-term decisions that go against your long-term interests. Keep your eyes on the prize and stay patient.
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stefon walters has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
