There is a reason why investing in the stock market is one of the best ways to generate wealth over long periods of time.
After all, there hasn’t been a single 15-year period since 1926 in which investing in the S&P 500 would have led to a loss of principal.
And over the same period, there was roughly a 25% probability of generating annualized returns of 15% or more.
So given those great odds, why is it that there are so many people who persistently lose money in the stock market?
Optionality may have something to do with it. After all, there’s only one sure (and very boring) way to make money in the stock market. Buy and hold. Rinse, repeat, don’t deviate.
And at the same time, there are so many exciting dumb things we can do with our money.
There’s that cool-sounding stock your brother-in-law mentioned over dinner. Chasing the next bubble with a couple of guys who look like they really know what they are talking about. Perhaps doing some day trading on the side.
Deep inside, we know we are going to get electrocuted eventually, but we just can’t resist hitting the big shiny “Get Rich Quick” button.
However, as crazy as they may sound, all of the options above at least have the potential to temporarily make you some money before you lose it all.
So if you want a truly guaranteed way to lose money in the stock market, you’ll have to do something different.
Selling After A Correction
Earlier this year, JP Morgan released the 2019 edition of their guide to retirement.
Despite being primarily oriented towards US investors, there are a couple of nuggets there that could benefit any reader.
There’s the evolution of happiness and stress by age. As it turns out, I’m about to get a lot less happy so watch out for a lot of grumpy posts:
There’s their test of the safe withdrawal rate.
According to JP Morgan’s analysis, even if you withdraw 4% of your portfolio per year (adjusted for inflation), there is a 20% likelihood the portfolio will quintuple in size over 30 years:
Most importantly, there is an analysis of what happens to your stock market portfolio if you panic and sell after a correction.
Please take a good, hard look at the numbers. If there’s one chart you need to remember during the course of your stock market investing career, it’s the one above.
Missing just 10 best days over a 20-year stretch cuts your returns by nearly a third.
Missing 20 days takes what was pretty much a sure bet and turns it into a money-losing strategy.
And any additional day after that just pushes you deeper and deeper into the red. When it comes to examples of self-inflicted pain and suffering, this is as good as it gets.
In addition, those of you with an eye for detail may have also noticed that the chart above has a box on it that says the following:
“Six of the best 10 days occurred within two weeks of the 10 worst days”.
That’s right. Investor sentiment is fleeting. Today it’s all doom and gloom but give it a few days and everyone starts talking about the bright future ahead. A year ago, everyone was freaked out as the stock market came off 20%. Investors were jumping ship left, right and centre.
And so they missed out on a 25%+ rally in 2019. Too bad.
So please tune in for the following public service announcement:
Don’t do drugs.
Don’t sell after a correction.
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
Find out more about me and this blog here.
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