Every investor eventually faces the same question. If a stock market correction looks likely, should you stop buying stocks and wait until conditions improve? It feels like a reasonable question to ask. But history suggests it’s a very consequential one.
Corrections aren’t rare, and investors should expect them from time to time. According to Fidelity, the S&P 500 (SNPINDEX: ^GSPC) has fallen 10% or more in 48% of calendar years since 1980. Yet the average calendar year return over that same period was 13.3%. In other words, investors who can ride out short-term stock volatility can still be richly rewarded.
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The rewards can be even bigger if you keep buying.
The benefits of continuing to invest through corrections
When stocks start falling, many people decide whether to sell their existing stock positions and whether to stop their periodic investment plans.
In general, the answer to both questions is no. Investors often hurt their long-term returns by trying to buy and sell based on short-term developments. But pausing new investments into your brokerage, 401(k), or other investment account is usually the biggest missed opportunity.
Let’s say the S&P 500 drops steadily, falling by 20% over the course of a calendar year. Over the next year, it fully recovers and returns to its all-time high.
If you hold your existing S&P 500 position but stop all periodic investments into it, your return on investment (ROI) would be 0%. You’ve essentially just made one big round trip to where you started.
But if you kept adding to their account, you would have spent two years buying shares at discounted prices. Every purchase would have been made at a price below that all-time high. Therefore, there would be a positive ROI on all of them. Your original investment would just be back to where it started. But your monthly investments and total account balance would be in the green.
Continuing to invest consistently throughout market corrections would have enhanced your long-term returns.
Treat the next pullback like a buying opportunity
If you’re going to do anything with your portfolio during the next correction, make sure it’s buying and not selling.
It’s easy to want to sell after stock prices have fallen. But most investors don’t have the stomach to buy back in when everybody is looking to get out. That’s a recipe for damaging your portfolio.