When it comes to the stock market, some investors seem to believe in the old adage “what goes up must come down.” They worry that after such an outstanding year in the markets, we must be headed for a fall. This month’s downturn is no doubt feeding those fears.
One way this kind of thinking manifests itself is in a reluctance to invest new money in equities because the market is “too high.” Other investors take it a step further and actually sell stock with the intention of buying back in “after the correction, when prices are more reasonable.”
Before the recent bout of turbulence, the stock market had provided exceptional returns dating back to pandemic crash in February and March 2020. In 2021, the Canadian market was ahead 25.1%, its best year since 2009, while the U.S. market produced a Canadian dollar return of 24.6%.
The 2021 gains put equity valuations at relatively high levels, according to such metrics as the Shiller CAPE 10. However, the same observation was made at the beginning of 2021. Then, the S&P 500 went on to make 70 all-time highs during the year.
As author Larry Swedroe notes in this article, valuation metrics shouldn’t be used to try to time markets. “While higher valuations do forecast lower future expected returns, that doesn’t mean you can use that information to time markets,” Swedroe writes. “And you should not try to do so, as the evidence shows such efforts are likely to fail.”
The advice is equally true for market pullbacks and the days when markets hit an all-time high. These periods are often the trigger for the media and individual investors to start speculating about how portfolios should be readjusted on the fly. That’s when people make wealth-destroying errors.
The danger of succumbing to anxiety by selling equities or holding off on new investments is two-fold. First, you will have to make the thorny decision of when it’s safe to get back into the market. Second, you risk missing out on strong returns while you’re sitting on the sidelines. If you want to know how that feels, just ask anyone who sat out 2021.
When it comes to investing, the antidote for unhealthy emotions is a long-term financial plan with asset allocation targets that reflect your objectives and risk tolerance. As the markets move up or down, you periodically rebalance your portfolio back to your target asset allocations and keep your faith that the process works over time.
Your goal should be to cultivate a long-term investor mindset. Long-term investors ignore the day-to-day noise that comes with volatility and stick to their plan with discipline.
Source: Dimensional’s Returns Web