People find out what I do for a living and I inevitably get everyone’s commentary on the markets. Not that I get too much new insight, but it is always interesting to hear people’s market sentiment and investment philosophy. For example, for more than a year I have heard a lot of people say they are waiting for that big 10% correction to come. I will hear the lines that the market is too high and we are in for a big correction, so they are on the sidelines waiting. The question is, does this waiting really work and does it end up doing more harm than good?
This was a topic at a recent Professional Investor Forum I recently attended in New York, were I heard some very interesting statistics. Looking at the markets from 1945 to 2013, in any given year there is a 57% probability of a 10% correction in the S&P 500. When valuations are “high”, as people have been saying for the last year, that probability goes up to 63%. Not as high as you would think.
The last 10% correction happened from May 1 to June 4, 2012, when there was a 10.4% drop in the market. We typically see a 10% correction at least once in a one to two year cycle. What’s interesting is that this correction took about a month from top to bottom. It was an ugly month. Now if on May 1 you would have gone on vacation to that far off island and not had access to the internet with market news, and then returned at the end of July, you would have just thought it was a boring flat market for the summer, because by that first week in August, we are back to the pre-correction levels. So you wouldn’t have noticed much difference.
Now if we continued to sit on the sidelines feeling that valuations were too high and saying “I know we are due for another 10% correction”, you would have lost around 37% in your portfolio. Wait, how did you lose money by sitting on the sidelines? The same way you “lost” 10% during that correction– it was all on paper. So if you stayed in the market during that correction period and ignored the headlines, you never really lost any money. Your account just didn’t go up as much as you would have liked it to. If you have been sitting on the sidelines waiting for that next correction, you technically only lost out on the amount your account could have appreciated while waiting for that correction to happen, or about 37%. If suddenly we got hit with that 10% correction right now, you would still be up around 27%.
If you think about it, what hurts more, participating in the correction or giving up the opportunity for appreciation in your portfolio? To me, the lost opportunity hurts more. Not only did you forgo 27% appreciation in your portfolio, but now you don’t have the money for that long summer vacation you could have been on while ignoring the correction and returning at the end of the summer to think your account was actually up 37%.
Remember, it is not market timing, but smart time in the market. Ignore the “gloom and doom” blogs and the “made for higher TV ratings” market news shows. Create a good diverse asset allocation and investment strategy, stick to your guns, and go enjoy a vacation once in a while.