The Importance of Staying Invested
Ending wealth values after a market decline
The image shows three different reactions to a recent investment loss.
The green line shows the experience of an investor who stayed invested in stocks.
The red dotted line shows the experience of an investor who exited the stock market and invested in cash.
And the orange line shows the experience of the investor who exited the market at the bottom but then reinvested in stocks a short time (12 months) later.
Investors who attempt to time the market run the risk of missing periods of exceptional returns, leading to significant adverse effects on the ending value of a portfolio.
The image illustrates the value of a $10,000 investment in the stock market during the period October 2007– January 2014, which included both the global financial crisis and the recovery that followed. The value of the investment dropped to $5,282 by February 2009 (the trough date), following a severe market decline.
If an investor had remained invested in the stock market over the next 59 months, however, the ending value of the investment would have been $10,155. If the same investor exited the market at the bottom to invest in cash for a year and then reinvest in the market, the ending value of the investment would have been $7,260. An allcash investment at the bottom of the market would have yielded only $6,394. The continuous stock market investment recovered its initial value over the next five years and provided a higher ending value than the other two strategies.
While recoveries may not all yield the same results, investors are well advised to stick with a long-term approach to investing.
Returns and principal invested in stocks are not guaranteed. Stocks have been more volatile than bonds or cash. Holding a portfolio of securities for the long term does not ensure a profitable outcome and investing in securities always involves risk of loss.
ABOUT THE DATA
The market is represented by the S&P/ASX 200 index, which is an unmanaged group of securities and considered to be representative of the Australian stock market in general. Cash is represented by the UBS Bank 0+ Years index. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs.
It is natural to have an emotional reaction to changes in fortune.
However, acting on that natural emotion can end up making things worse; investors may leave the market and miss out on the subsequent recoveries.
An investor who exited the market at the bottom, waited for a year, and then reinvested would have missed out on fully half the recovery in stock prices.