The Stock Market Downturn Isn't as Bad as You Think (Probably)
The stock market just wrapped up its worst first half of the year in more than five decades. With the S&P 500 index in a bear market (down more than 20% from its previous high), it’s easy to get discouraged — especially if you’ve been keeping a close eye on your 401(k).
It's times like these that perspective is very important: Despite how painful the downturn may feel, your portfolio is probably doing just fine.
Including the recent downturn, the three-year annualized return of on the stock market “is still over 8% a year, which is pretty good,” Anqi Chen, the assistant director of savings research at the Center of Retirement Research at Boston College previously told Money. That's thanks to a sustained period of strong growth for stocks between March of 2020 and the end of 2021, fueled in particular by the soaring tech sector.
Even so, it’s probably difficult to feel good about those gains right now. You can blame your brain.
For one thing, it's hard to grasp how unusual the high returns of the last few years were in the grand scheme of the stock market's ups and downs. That's thanks to a psychological phenomenon called anchoring bias, which keeps investors fixated on a specific piece of information that overshadows other facts, instead of bearing the larger picture in mind.
"We filter the decline in stock prices relative to the peak," Chen told Money, "rather than a longer history."
There's also a bias called loss aversion, which makes the pain of losing money much more intense than the happiness associated with gaining the equivalent amount. That's why it's common to feel despondent (and compulsively check your 401(k) balance) when the market is falling. It's also why easy to forget about your investments and take things for granted when stocks are doing well.
A related phenomenon called the endowment effect, which describes how people view things they own as more valuable than their true market value, is at play too. Because of this, investors can feel attached to their past two years of rising stocks even if they hadn't realized any gains by selling them, Chen says.
A bear market can be a buying opportunity
If you’re anxious about your portfolio losing value this year, remember that these losses are only realized if you sell. Thinking about the long-term horizon of your investments can help too. Stocks generally recover from bear markets within about two years, and the market has never had a negative annualized return over a 20-year period.
While a downturn can be scary, it’s actually the best time to leave your money invested — provided you have a long-term strategy and can afford to do so. Making changes to your portfolio because of short-term volatility is never a good idea, and staying invested will ensure you don’t miss out on future good days.
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