As Jerry Seinfeld told his friend George Costanza, “If every instinct you have is wrong, then the opposite would have to be right.” If you’re like most people, then your instinct throughout this extreme market drawdown has been to sell. The instinct grows stronger with each passing day and each time the market hits its limit down, which is the maximum that the market is allowed to fall per exchange rules during a certain time period.
Still, we know that selling in the middle of a drawdown has historically been a fool’s errand. The famous adage doesn’t tell us to be fearful when others are fearful, but rather greedy. Again, it’s the opposite that is true. Instead of succumbing to our natural instincts and middle of the night compulsions, we instead adhere to long-term principles of sound investing, such as consistency and courage, and use historical perspective to ground us in optimism and guide our decisions.
How can we use historical precedent to prevent us from making bad decisions at inopportune times? Let’s consider the cases of three hypothetical investors during the global financial crisis. Each has $100,000 in the equity market at its cyclical peak on October 9, 2007.
- Investor Buy and Hold stays the course throughout the full event.
- Investor Sit Out for a Year eliminates the full equity position in October 2008 during the peak month of outflows for global equity mutual funds and exchange trade funds; only to buy back in one year later.
- Investor Wait for Good Data eliminates the full equity position in October 2008 during the peak month of outflows for global equity mutual funds and exchange trade funds; only to buy back in March 2010 once the default rates for subprime mortgages finally peaked.
Who did best?
- Investor Buy and Hold, having experienced the full market decline, saw their account bottom at $48,000 in March 2009. By April 29, 2011 (897 trading days) the account was back to whole. By the end of 2019, Investor Buy and Hold had more than $276,000 in the account.
- Investor Sit Out a Year and Investor Wait for Good
Data never saw their accounts fall below $60,000 during the financial crisis. Each
of them, by selling in October 2008, prevented additional losses of $12,000.
- However, Investor Sit Out a Year, by waiting a full year before investing again, missed out on many of the best days of the recovery. This investor did not get back to whole until March 13, 2013—a full 1,366 days from the initial investment. Investor Sit Out a Year, by the end of 2019, had $44,000 less in the account than did Investor Buy and Hold.
- Investor Wait for Good Data, by waiting until subprime defaults peaked to once again invest, didn’t get back to whole until for 1,379 trading days and has slightly less in the account today than even Investor Sit Out a Year does.
The buy and hold strategy proved to fair the best, notwithstanding experiencing the greater loss during the financial crisis. It’s time in the market that tends to matter most. Let’s apply the wisdom of George Costanza and say, “Yes, I will do the opposite.”
The source for all performance returns is Bloomberg, as of March 24, 2020, using the Dow Jones Industrial Average as a measure of stock returns. The Dow Jones Industrial Average Index is designed to measure the performance of 30 large capitalization U.S. stocks. Returns calculated are total returns which include reinvested dividends. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results.
The opinions referenced above are those of the authors as of March 26, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.