Why You Should Not Sell When the Market Crashes
BY BRANDON VAGNER, CPA, Ph.D., & WALLET WIT FOUNDER
One of the reasons I’m so passionate about this Wallet Wit blog is that it allows me the ability to give people a look into my personal financial decisions (good or bad) and how those decisions play out. It’s one thing to listen to really wealthy people tell you to keep your money in the market during a market crash, but it’s another thing to see exactly what that looks like within an average person’s retirement account. In this article, I’ll show you proof and outline 5 KEY reasons why you should not sell when the market crashes.
Here is my personal retirement account performance summary. I wanted to share with you exactly what happened to my account when I did not sell anything during the latest market crash.
Keep in mind that the market absolutely tanked during the early part of 2020 due to COVID-19 and the related market reaction. The market was at an all-time high in February 2020 and then sharply dropped 35% by March 2020. This is the point where many people let their emotions get the best of them and as a result sold their retirement investments out of fear they will lose everything.
Check out that middle column in my performance summary above. From the beginning of the year to June 30th my six month loss was only 1.73%. That is drastically different than what most people feared. The market had almost completely corrected in that VERY short period of time from February to June 2020.
Check out my 12 month performance ending June 30th. Notice how it reflects a 6.42% gain. That 12 month time period included that 35% market crash in early 2020. This is evidence of how powerful it is to not try and time the market, steadily invest, and most importantly keep your cool during a market crash.
Before we dig into the primary reasons why you should not sell when the market crashes, I think it’s important to highlight that there is a very small percentage of the population who are professionally trained enough to recognize early a crash is beginning to occur, sell high, and then buy low, BUT it’s extremely difficult for the average person to effectively time strategic trades during a market crash. Trying to time the market can be extremely devastating to a retirement portfolio. There is a reason why I don’t try to time the market. It’s just flat hard. Being consistent with my investment strategy and trusting the market to recover has paid off for me.
Reason #1: History Shows You Should Not Sell When the Market Crashes
My retirement performance summary is solid proof for why you should not sell when the market crashes, but history has repeatedly shown us selling investments during a market crash is a bad idea.
The historical line graph above showing the Dow Jones Industrial Average from 1999 – 2020 includes 3 dips in the market that really rocked retirement accounts at the time. Take note of the dot com bust from 2001 to 2002; the great recession market crash that began November 2007 and bottomed in March 2009; and the COVID-19 related market crash that began February 2020 and bottomed in March 2020. The market recovered every time.
We could go back even further to the beginning of the market and you would see that over time the market always recovers. That said, it can take time. If you are really close to retirement, then your portfolio needs to be structured to withstand a long period of recovery. The mistake most people make is that they are emotionally reactive to market crashes instead of being proactively prepared.
Reason #2: Diversification Protects From Unrecoverable Loss
A market crash would be REALLY scary if you only had a few stocks or even worse just one stock. Just look at all the financial trouble businesses are in as a result of the COVID-19 pandemic, and many people have lost their retirement savings because they had all their eggs in one basket.
The key to remaining calm during a market crash is knowing your portfolio is diversified. If you had 30 high quality dividend paying stocks and one or two of those businesses went completely under during a market crash, mathematically you will be just fine over time because your other 28 investments will go to work for you. However, if you were only invested in those one or two stocks that went belly-up, then you wouldn’t even have a chance at recovering your loss through your investment portfolio.
Most people don’t want to take the time to research and pick individual companies to invest in. I don’t blame them, because it is a lot of work if you do it the right way. Fortunately for those people and myself, mutual and index funds exist. Both mutual funds and index funds allow you to be diversified without all that work.
A Mutual fund is an investment into a collection of many companies determined by the mutual fund managers. This collection of companies is sometimes referred to as underlining assets. Whereas, an index fund matches returns of a market index such as the S&P 500, which is referred to as a stock market benchmark. The Dow Jones Industrial Average would be another one. Using the S&P 500 index fund as an example, you can basically think of it like you’re investing in the 500 largest U.S. publicly traded companies.
Related: Best Place to Buy a Mutual Fund
Reason #3: Selling Based on Emotions Is a Bad Idea
Fundamentally, a retirement account should be designed for the long haul, but are you emotionally ready for the guaranteed ups and downs over the long haul? A retirement account should be evaluated on a periodic basis, but you shouldn’t feel like you have to scramble to sell during a market crash.
From purely a principle perspective, your retirement portfolio should be setup so you don’t have to sweat market reactions to short term events. If you did your homework in the beginning and crafted a well diversified portfolio, then you should be fine over the long haul.
The bottom line, you should not sell when the market crashes because your emotions are getting the best of you. Fear is very complex, and investment decisions based on fear can be absolutely devastating. Investment decisions need to be well thought out and you should be able to trust your long-term plan. I’m not saying it won’t be difficult when you see your account balance dropping, but you have to recognize when your emotions are getting in the way of sound decisions.
Related: How to Overcome Fear
Reason #4: Selling Can Add Years to Your Retirement Timeline
For simplicity purposes, let’s look at an example. Let’s say you had an investment balance of $100,000 at the beginning of a market crash. Let’s also assume the market then crashed 35% like we experienced during the COVID-19 market crash. If you sold at the bottom, that would mean you sold at $65,000, in this example. Let’s see how that decision might impact your retirement plans.
Let’s make just a couple more assumptions. Let’s assume you are 35 years old and want to retire at 60. That means you would have 25 years left to hopefully take advantage of compounding interesting. Again, for simplicity purposes, let’s assume the person who sold waits a year and gets back in the market one year later. Also, let’s assume you never invested another dollar for either scenario and the market averaged a 7% annual return during that 25 year period leading up to your desired retirement age.
If you run the math on the difference between the person who sold at the bottom of the market at $65,000 and reinvested a year later compared to the person who kept their cool and stayed in the market, the difference between the two retirement accounts would be about $200,000. The person who got back in the market a year after the crash with their $65,000 would have an account balance of about $330,000 at the age of 60. Whereas, the person who never sold would have an account balance of about $530,000 at the age of 60. That’s a massive difference and very well might add years to someones retirement timeline.
It’s important to point out these numbers were based on specific assumptions, and people certainly may realize different results given actual market returns over the next 25 years.
Also, keep in mind that within 4 months of the COVID-19 market crash bottom, the market as a whole had fully recovered from an investment perspective. Yes, many businesses were still struggling, but many well diversified investment portfolios had recovered. Just look at my account performance above as an example.
Reason #5: Selling Low Can Be Mentally Devastating
Piggy backing on my example above and knowing the market recovered within 4 months, if you had sold at the bottom of the market crash, you would have to live with the fact that you missed out on immediately recovering your $35,000. That is very hard to mentally process given how much time it takes for the average person to save $35,000. If you were to then reinvest the $65,000 at the height of the market, it would take you an incredible amount of time to earn that $35,000 back AND you still would have the risk of another market dip. Thus, potentially taking your investment balance even lower than $65,000.
Because investing is such a long game, it can be mentally devastating to think about how many years of compounding interest you lost from getting out of the market at or near its low point. It can also be mentally devastating to think about how that decision might literally add years to your planned retirement age.
I know it can be extremely difficult for anyone to navigate a market crash. It’s emotionally draining and has the potential to significantly impact your retirement plans. I hope these five 5 reasons why you should not sell when the market crashes helps you make your decision.
All of this said, it’s very important to understand everyone’s investment portfolio is different and people may have other opinions. These are simply my opinions. The information provided in the Wallet Wit website should not be construed or relied on as financial, tax, investment, or legal advice. Articles within the website are designed for informational and entertainment purposes only.