Beginner’s Guide to Market Volatility

Here's how quickly the stock market recovered after similar downturns

Twenty/20

The U.S. stock market tumbled 7.3% in three days of trading, from Friday through Tuesday, something that's happened 24 times for the S&P 500 in the past two decades. The market recovered after each of these slumps, though, relatively quickly. And this benchmark has more than doubled in that time.

The majority of three-day slumps like this happened during the last two bear markets — from March 2000 to October 2002 and October 2007 to March 2009 — when the S&P 500 was in the midst of sell-offs of 49% and 57%, respectively, from prior highs.

Outside of those bear market-era periods, here's what has happened in the wake of even worse multiday sell-offs since 2000:

  • 2015: In a six-day stretch in August, the S&P 500 tumbled nearly 12%. About two months later, the benchmark had recouped all of those losses.
  • 2011: In three days that August, the S&P 500 slumped more than 11%. It had recovered from those losses by late October, less than three months later.

The S&P 500 jumped higher in early trading on Wednesday before ending the day slightly lower. The index is down 8% from its all-time high last week, which still is nowhere near bear market territory yet.

And while the market's current decline doesn't yet qualify as a correction, or a decline of at least 10% from a recent high, these events also highlight the market's resilience. Since World War II, the average correction for the S&P 500 has lasted four months, and it took another four months for the market to recover, according to analysis by CNBC and Goldman Sachs.

When stock prices are plunging over a matter of days, it can test anyone's resolve. But periods of turbulence can actually be good for long-term investors. Legendary investor Warren Buffett, who began investing in the 1940s, has certainly seen worse and even in 2008, in the midst of the financial crisis, his advice was: "Buy stocks."

Here's why keeping a long-term perspective is important when investing.

The market has always bounced back

Even with the latest market slump, fueled by fears that the deadly coronavirus will hamper global economic growth, the S&P 500 is trading at levels last seen a matter of weeks ago in December. And while this gauge is down less than 4% for the year so far, it's still up almost 12% in the past 12 months, and a whopping 48% in the past five years.

Even at its worst, a bear market, the stock market has always bounced back. These types of slumps aren't very common, but they're severe in both duration and the extent of market losses. The average decline during the post-World War II bear markets has been 30% over a 13-month period, and it's taken the market another 22 months to recover.

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For someone like Buffett, who has been buying stocks during the market's best and worst times, a 3% decline in one day is just a blip. In fact, the S&P 500 has endured 88 declines about as bad as Monday's 3.4% slump during his investing horizon.

"Now coronavirus is front and center. Something else'll be front and center six months from now and a year from now and two years from now," Buffett said on Monday. Rather than trying to predict that market's moves in the short term, he says investors are better off focusing on the long-term merits of investing in U.S. businesses.

"We think the 20- and 30-year outlook is not changed by coronavirus," Buffett said.

How to take advantage of market dips

Given that the market has always bounced back following significant dips, it's possible to seize the opportunity and buy more when prices are lower. You can take advantage of these declines in two ways: by dollar-cost averaging and by lump-sum investing.

With dollar-cost averaging, you regularly add money to your portfolio over time, which ensures that you buy at a variety of prices, regardless of whether the market is tumbling or soaring. You will invest the same amount of money on a regular schedule — like each Friday, every other Tuesday, or the second Wednesday of each month. Doing so simplifies the investing process, removes the temptation to try to time the market by predicting when prices will be higher or lower, and removes any potential emotional bias.

With lump-sum investing, you take a more tactical approach. If you see that the market has fallen by a certain amount, you'll dive in with money you've been saving up for this exact purpose. For example, if you receive a tax refund, a smart way to use that money is to invest it in the market. The goal here is to buy at the lowest possible price.

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Which strategy wins? If you happen to have the timing right, an immediate lump sum investment in the U.S. market has outperformed a dollar-cost averaging approach over a 12-month period by nearly 2.4 percentage points, according to research conducted by Vanguard. However, the research shows, dollar-cost averaging minimizes the potential for regret. And it's rare that most people will come upon the kind of windfall that might make a lump-sum investment attractive.

That's why experts recommend that instead of accumulating a set amount to invest all at once, you start sooner and with smaller increments.

Finally, rather than trying to pick the winners in the stock market, a proven strategy for long-term investing success is to just invest in the market itself by buying index funds that track the performance of a particular benchmark, like the S&P 500.

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