Investors sometimes feel anxious when markets are volatile like they are now. It can be tempting to stop regular investments account deposits if your portfolio loses value temporarily. When it comes to investing, in volatile markets, what feels right can often be wrong. In this post, we’ll show you why it’s important (and even beneficial) to keep investing despite market volatility.
Three graphs were shown to illustrate different market behaviors in an investment seminar I delivered years ago. I asked them which type of market they would prefer to invest in periodically each year if they didn’t intend to withdraw their money until 10 years from now. These graphs illustrate how an index-based ETF might fare in different market scenarios.
You probably won’t be surprised to learn that Chart A was the most popular choice, while Chart C got the fewest votes. You might be surprised to learn that Chart C is actually the best market environment for investing in, and Chart A is the worst.
Investing in different market conditions
Let’s dig into the numbers associated with each scenario.
Investing on a continuously rising market
Table 1 shows an example for an index-based ETF price and the number of shares that an investor might purchase in a steadily increasing stock market (Chart 1) if they invest $1,000 every January 2, for the next ten years.
As you can see, our investor will own 46.55 shares of the ETF, which will be worth $23,275.49 when they’re ready to liquidate their portfolio after 10 years.
Investing in a volatile but growing market
Imagine our investor facing a volatile but growing market for the next 10 year. The table 2 shows the potential purchase price per share as well as the number of shares that can be purchased for the same ETF under those market conditions.
On the 10th anniversary of their original investment, the investor will own 48.42 shares of the ETF, which will be worth $24,209.76 when they’re ready to liquidate their portfolio. You will get more value investing in volatile markets at a constant rate than in rising markets. That’s because the investor gets to buy investments at a relative discount due to interim volatility.
Investing in a falling market
Table 3 shows an example for how much an index-based ETF could cost and how many shares it might offer investors in a declining stock market. It is based on an investor investing $1,000 every year starting January 2.
This third scenario, shockingly, has the highest liquidation value. That’s because in effect you’re buying the ETF at a steep discount. It doesn’t matter that the ETF declined during your investment period. All that matters is what it’s worth when you’re ready to liquidate your account.
In a volatile market, you can still make money
Our example shows that interim volatility doesn’t matter; a volatile market can actually work to investors’ advantage because it gives them opportunities to buy at a relative discount. That doesn’t mean you should wait for a volatile market to invest, because it’s almost impossible to time the market. The lesson is you should ignore the behavior of the market if you intend to invest steadily and don’t plan on touching the vast majority of your account value for a number of years.
Markets tend to rise over time. So if your investment horizon is fairly long (at least 3-5 years), then what happens in between doesn’t matter very much as long as your portfolio is ultimately worth more than what you paid for it.
Don’t be driven by fear of loss
Loss is uncomfortable, even if it’s temporary. But it’s important to remember that volatility is a normal part of investing, and you don’t actually lose any money unless you sell your investments for less than what you paid for them. History shows that markets tend to rise in the long run, which means if you stick to your strategy and keep investing, you’re likely to come out ahead.
This post was inspired by an example from Elements of InvestingWealthfront CIO Burt Malkiel (with Charley Ellis as our investment advisory member) shows how little impact current market conditions have on the outcome of your investments. You just need to make a plan and stick with it, no matter how the market changes.