The S&P 500 index enjoyed its biggest first-quarter gain this year since 1998, which made me wonder: How many people missed out on this rally? The growth came after the index was walloped in the fourth quarter, with the index down 13.55% for that period. Surely, the thought of cashing out passed through many investors' minds.
Suppose you did get spooked last year during the fourth quarter, and you gave up by selling off your positions, trading your investments for cash. Eventually you'll get back in the market when the worst is over, you tell yourself. That sounds like a reasonable strategy. However, waiting it out also means potentially missing some very big up days in the market -- days that can make an enormous difference in your portfolio's performance over time.
If you're thinking of getting out of the stock market after a drop, you may be giving up big gains on the rebound. Image source: Getty images.
Time in the market, versus time out of the market
JP Morgan Asset Management's recently published 2019 Retirement Guide shows the impact that pulling out of the market has on a portfolio. Looking back over the 20-year period from Jan. 1, 1999, to Dec. 31, 2018, if you missed the top 10 best days in the stock market, your return was cut in half. That is a significant difference in return for only 10 days over 20 years! The below table shows the growth of $10,000 over those 20 years if you stayed invested or if you missed some of the up days.
| January 4, 1999 to December 31, 2018 | Dollar value | Annualized Performance |
|---|---|---|
| Fully invested (S&P 500 Index) | $29,845 | 5.62% |
| Missed 10 best days | $14,895 | 2.01% |
| Missed 20 best days | $9,359 | -.33% |
| Missed 30 best days | $6,213 | -2.35% |
| Missed 40 best days | $4,241 | -4.2% |
| Missed 50 best days | $2,985 | -5.87% |
| Missed 60 best days | $2,144 | -7.41% |
Source: JP Morgan.
The table clearly shows you don't have to miss many good days to feel the impact. The return went from positive to negative by missing only the 20 best days of the market over 20 years. Putnam Investments studied the data from 2003 to 2018 and found similar results. If you were fully invested in the S&P 500, your annualized total return was 7.7% during that time. But if you missed the 10 best days in the market, it dropped to a paltry 2.65%.
Missing out compounds over time
If you're guilty of missing some of those really big days in the market, you're not alone. Investment research firm Dalbar publishes an annual survey of the average investor's performance versus the benchmark. Dalbar studied retail equity and fixed income mutual fund flows (money in and out of the fund) each month from December 31, 1997 to December 31, 2017 to calculate the "average investor" return. Turns out the average investor performed below average when compared to buying and holding the S&P 500 Index.
The table below shows that in the 20 years from 1997 to the end of 2017, the average equity investor was up only 5.29% versus the index, which was up 7.2%, a difference of almost 2 percentage points (based on average annual total returns). The average fixed-income investor fared even worse. Over the same time period, the Barclays Aggregate Bond Index was up 4.98% but the average fixed-income investor was up only 0.44%. One of the main reasons average investors lagged the benchmark was due to mistiming the market or missing the up days.
| Ending dollar value | Average Annual Performance | |
|---|---|---|
| Average equity investor | $280,377 | 5.29% |
| Standard & Poor's 500 Index | $401,346 | 7.2% |
| Difference | $120,969 | 1.91% |
Source: American Funds and Dalbar.
The Dalbar study highlights how missing a few of the market's up days leads to lackluster performance over time. Of course, the reverse is true, too. If you are out of the market, you are also missing the potential worst days as well. But over time, as you can see from the two tables, if you're going to invest in the equity markets, you have to be in it to win it. This means riding through the bad days to get those good days.
It's interesting to note that many of the best days in the market come after the worst days. According to the JP Morgan study, six of the 10 best days came within two weeks of the 10 worst days. One example was in 2015: The best day was Aug. 26, only two days after the worst day in the stock market for that year.
The lesson here is that investors are rewarded for sticking to their investment plan and riding out the bad days in the market over time. It may seem harmless to wait out the bad days, but this means potentially missing the up days that boost performance over time.
One way to help your portfolio weather an impending storm in the stock market is through smart asset allocation -- having money in both stocks and bonds. Traditionally, bonds have done well when stocks slide. If that's the case, asset allocation may help lower the volatility in your portfolio. Fewer hiccups in your portfolio may help keep you from panicking and selling out in the tough times like last year. The bottom line is: Don't miss the good days!