The stock market has fallen by 14% since the start of the year. It could yet decline even further as risks such as geopolitical uncertainty in Europe and rising interest rates impact the economy’s future outlook. As a result, the prospect of a bear market does not seem unlikely.
Some investors may decide that now is the right time to sell shares. They may determine that a challenging economic and geopolitical outlook means that it is better to hold lower-risk assets, such as cash, instead of increasingly volatile equities. In doing so, they may avoid experiencing further paper losses in the short run.
However, in my view, selling shares now would be a major mistake unless the company has entered some sort of permanent decline. Certainly, stock prices could come under further pressure in the near term. But, over the long run, they offer significant capital growth potential, and trying to time the market often ends up being counterproductive.
Making a mistake
The U.S. stock market has experienced numerous downturns and bear markets in recent decades, but it has always fully recovered from them to post new record highs. In fact, the S&P 500 has generated a total annualized return in excess of 10% in the past 50 years in spite of it experiencing eight bear markets during that time.
As a result, holding onto high-quality companies during downturns could be a more logical strategy. This viewpoint has previously been highlighted by Peter Lynch, who generated a 29% annual return when managing the Magellan Fund between 1977 and 1990. As he once said, “The key to making money in stocks is not to get scared out of them.”
A simple approach
Clearly, it is difficult to hold onto any stock that is falling in price. It is natural for any investor to be tempted to sell so that they can avoid further fear and worry. But it must be remembered that any losses are not realized until a stock is sold. Paper losses can quickly become paper gains once a stock market recovery takes hold.
A checklist could make it easier to avoid being scared out of stocks. It may encourage an investor to focus on company fundamentals instead of the market’s recent performance or prospects. For example, a checklist that includes a section on company finances may prove to an investor that their holdings have the means to survive a period of economic difficulty so they can benefit from a subsequent recovery.
Relative opportunities
In addition, focusing on the lack of appeal of other assets may encourage investors to stick with their high-quality stock holdings. For instance, cash currently offers a hugely negative after-inflation return. Similarly, bond prices are likely to come under pressure as interest rates rise. Meanwhile, real estate investments may also suffer from an increasingly tight monetary policy.
Undoubtedly, share prices could fall further in the short run and underperform other assets in the coming months. But their past performance suggests they offer long-term growth potential for investors who are able to take a long-term view and avoid impulse selling during a downturn.
