Personal Finance

You might be warming to the stock market. Be prepared for it to drop

Key Points
  • If you've decided the stock market isn't so bad after watching it rebound over the last several months, be aware that its positive momentum could shift at any time.
  • If you don't stay invested through the dips or dives, you may not benefit from the long-term growth potential.
Rowan Jordan

If you're feeling more warm and fuzzy about stocks lately, be sure to know thyself.

The stock market now ranks as the best place to put money not needed for at least a decade, according to a Bankrate survey of investors, with 28% choosing it, compared with 20% a year ago, when real estate was tops at 31%.

While the increased faith in the stock market could be viewed as a positive — savers see its long-term growth potential — it also comes with a downside: The sentiment comes on the heels of a big market run-up.

"Investors tend to chase performance, and that's concerning," said Greg McBride, chief financial analyst at Bankrate. "That tends to lead people to buy when prices are high and then sell at lower levels if they panic."

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While the U.S. economy continues struggling to gain firm footing amid high unemployment and uncertainty about when the Covid-19 pandemic will be under control, the major stock indexes continue to dance far above their early year lows. The S&P 500 index closed Wednesday at 3,276, up about 46% from 2,237 in late March. The Dow Jones industrial average finished the day at 27,005, up 45% from 18,591 on March 23.

He said that while it's encouraging that investors see the value of the stock market, there's likely more volatility ahead. And unless you can stay put when there's a dip or dive, you may not come out ahead down the road. 

"Everybody has risk tolerance when the market is going up," McBride said. "But how do you respond when the market tumbles?"

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He suggests doing a self assessment by reviewing how you responded in February and March when the market tumbled by a third before rebounding. 

"Did you ride it out and have the fortitude to buy more, or did you jump out and are just looking to get back in?" McBride said.

"You won't get higher returns in the stock market unless you're willing to ride out the ups and downs and buy more when prices fall," McBride said.

The chart below shows how $10,000 invested in the S&P 500 index, for the 20-year period of 1999 through 2018, would have performed under various scenarios.

If the $10,000 remained fully invested, it would have grown to $29,845 with an average annual return of 5.6%.

In comparison, missing out on just the best 10 days in that time period would have reduced the growth of the initial investment by more than half: After 20 years, that $10,000 would be just $14,895 with a 2% average yearly return.

And if the best 20 or more days were missed, the returns over that 20-year period are in the red.

In other words, it pays to stay invested even during volatility.

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