Trading Strategies: Buy and Hold vs Panic Selling
The greatest bull market in the history of America ended around March 11th, 2020. This caused many 401(k) account holders to take inventory of their investments. Financial professionals often preach the importance of the “buy and hold” strategy— especially for long term investments such as small business 401(k) plans — a point I emphasized at the beginning of the COVID crisis. Investors should be disciplined to avoid selling stock investments selling equities during a trough in the market. Now, let’s dive deeper into the ramifications of selling during the panic stage of COVID-19 and different types of trading strategies.
The media zestfully reported the end date of the America’s longest bull market in financial market history. As of the end of June 2020, weekly U.S. unemployment first-time claims are still above one million and global GDP is heading towards a recession. (“Recession” is defined as two consecutive quarters of the GDP contraction. A “depression” is six consecutive quarters of such GDP contraction). Despite those negative economic indicators, the S&P 500 has rebounded significantly since hitting bottom on March 23rd, 2020.
On the surface, it may seem unusual that stock prices have been growing amidst the never-ending stream of negative news. Keep in mind, however, stocks represent ownership in a company and their value is predicated on future — not present — earnings.
Consequence of Selling Low During COVID-19
401(k) plans are such a wonderful savings vehicle — you are easily able to make deposits through payroll deduction; they are long-term investments; and with easy access to low-cost 401(k) investments, continual deposits at regular intervals, you can reap the benefit of dollar-cost averaging. Even though we are less than half a year into the financial crisis brought on by COVID-19, a panic move (selling at the bottom of the market) could have already robbed you of years of retirement income. Let’s look at three different 401(k) account scenarios.
Let’s assume a participant started the year off with an even $200,000, contributed $500 each semi-monthly pay period (15th and last day of month), and invested exclusively into the S&P 500. If that participant continued to contribute as usual and remained invested in the S&P 500, here is how the account would have performed:
The following is for illustrative purposes only; you cannot invest directly in an index.
Compare that with what would have happened if that participant just stopped making contributions on March 13th, 2020.
The difference in ending balances (continuing to contribute vs stopping on March 13th) is $6,970.06, compared to the missed contributions of $6,000. Not only is that participant not saving for retirement, but they also missed out on $970.06 in earnings on those contributions.
Now let's look at the ultimate panic move: selling S&P 500 investments on March 13th and stopping contributions.
Historically, the S&P 500 averages an 8% annual rate of return over the long-term. In scenario 3, this participant would have locked in their losses at 15% less than what they began the year with. This is the type of panic sell that does irreversible harm to a 401(k) participant’s nest egg, as they will never have the chance to recoup the earnings they lost while being out of the market.
These three simple scenarios are the exact reason financial advisors endlessly preach the benefits of a diversified “buy and hold” are types of trading straegies for long-term investing.
When making sense of the quick rebound of the financial markets, it’s important to remember the concepts of Efficient Market Theory and Modern Portfolio Theory. Both theories represent the basis for the long-term buy and hold strategies and are well-known and respected in the financial industry. It is human nature to feel the need to “do something” if you look at your 401(k) account and see the balance going the wrong way. The truth is, the market is emotionless, so when it comes to managing your retirement nest egg, you must remove your emotions from the decision-making.
