Why should you continue investing when the markets are falling?

Experts often refer to volatile markets as falling markets. It’s better to call things by their name: almost always when we talk about volatility, we’re actually referring to market declines.

When markets fall, as they have in recent weeks, investors often question whether it makes sense to invest.

When your portfolio temporarily loses value, it can be very tempting to try to minimize your losses by halting your investment plan or your recurring contributions to your investment account (or even closing your investment account).

What happens, and this may be counterintuitive to most, is that in a bear market environment, what seems better is actually worse.

What market situation do we prefer?

If we take a moment to reflect, we will understand why it is important (and even beneficial) to continue investing despite being in a bearish (or volatile) environment.

We simulated three scenarios that could occur in, say, fifteen years. In all three scenarios, we invested €1,000 annually in a portfolio of index funds or ETFs.

We defined the three scenarios as follows:

1. Bullish: Continued increases in the stock markets
2. Stepped: The market is rising but has corrections
3. Bearish: The market has ten years of market declines before eventually recovering

Stop for a moment and ask yourself: Which chart do you prefer?

To help you, in the chart above, we’ve changed the colors to see if we can influence you…

Although in this version of the chart the bull market is grayed out, we’re sure that for most people it would be your choice, right?

Certainly, from a psychological perspective, it’s the easiest to bear. Why?

Because we see how, period after period, our investment grows steadily, and there are no market declines or shocks throughout the entire period. It’s the ideal world for our minds.

We can probably handle the stepped market too.

The staggered market is similar to what happens in real markets. Market rises are followed by market falls, and these occur endlessly with more or less regularity.

In reality, there may be sharp market falls, but in this case, the corrections are gentle. If we educate our minds at least a little, we will probably be able to stick with our investment plan.

The one that seems very difficult to endure, without a doubt, is what we have called a bear market. Is it really easy to endure 10 years of falls?

What seems best is the worst

n the following table we will demonstrate that in reality it is quite the opposite.

What seems best is actually the worst.

In other words, what is psychologically easier to bear turns out to be the worst option from the perspective of the final return on our investments.

If we look at the chart above, we see that from a numerical perspective, the worst (bear market) is clearly the best, and we accumulate the maximum, €83,300.

On the other hand, what is easier to bear, what we have called the bull market, is the worst from a profitability perspective, as we only accumulate €31,553.

The scenario we have described in steps would be an intermediate case in which we obtain €35,046.

The market rewards risk

In the following graph we see exactly the same drawing if we represent the CAGR of the three different scenarios.

The bullish scenario has the worst APR at 10%. The stepped market has a slightly better APR at 11%. The market we labeled as bearish clearly has the best APR at 22%.

Why does this happen? If we go back to the table above, we’ll clearly see why. The more the market falls, the more shares we accumulate with our €1,000.

In the first case, roughly speaking, we accumulate 78 shares from our imaginary basket; in the second, 87 shares; and in the third, many more, 208 shares.

Since all three scenarios ultimately end at the same point, in both the stepped and bearish scenarios, we have accumulated more shares, which ultimately have greater value.

Let us remember that the market rewards risk.

There are even strategies that involve investing more money when the market is lower.

Don’t let yourself be carried away by the fear of loss

We’ve discussed on other occasions how our brains aren’t designed to withstand losses and how the fear of losing prevents us from winning, as we are much more sensitive to losses than to gains, and this leads us to make inconsistent decisions.

What this example demonstrates is that temporary losses lose importance over the long term; a volatile or falling market can actually be better for investors because it gives them the opportunity to buy at a discount. Interestingly, buying at a discount is something we easily understand when making other types of purchases, such as clothing, household appliances, and even when we think about buying a home. But we struggle to grasp the concept of a “bargain” when we buy financial assets. It should be easier to understand when we buy the best indices in the world (our portfolios are made up of the best global indices).

We are not recommending, on the other hand, waiting for market declines to invest: it is impossible to predict the best time to enter or exit the markets. The lesson here is that you should try to ignore short-term market noise, especially if you intend to invest consistently and are investing for the medium to long term (the ideal and most advisable situation).

Markets have a natural upward trend.

Therefore, if your investment horizon is fairly long (at least 3 to 5 years), what happens in the short term doesn’t matter.

We realize this is easier said than done. Losing money causes uncertainty and discomfort, even if it’s only for a few months. In fact, even the most experienced investors suffer from it. But it’s important to remember that volatility and market declines are normal in investing, and you don’t actually lose money unless you sell your investments.

Remember, if you’re investing for the long term, you don’t need to sell.

History shows that markets tend to rise over the long term. This means that if you stick to your recurring investment plan and keep investing, history and statistics indicate that you’re likely to come out ahead.

Appendix: A real-life example from “the lost decade”

The 2000s are often referred to in the financial world as “the lost decade.”

This is because the dot-com bubble burst in 2000/2001 and, secondly, because the Great Financial Crisis occurred between 2007 and 2009.

Even so, on December 31, 2010, the MSCI World Index, for example, was 23% higher than on January 1, 2001. However, as we can see in the chart, an investor who had invested during this period would have had to accept an initial drop of -38% and then a worse one, during the Great Financial Crisis, of -45%.

Truly difficult times to invest.

Does this mean that an investor who had maintained his plan and invested regularly would have gone bankrupt during this period?

Of course, no!

It’s clear that it wouldn’t have been the best decade to invest, but if we look at the following table…

…an investor who had invested €10,000 each year would have earned an APR of 5% and accumulated around €25,000 in profits, if they hadn’t panicked at the worst moments.

On the other hand, an investor who had sold during the stock market crash, for example, on December 31, 2008, would have lost €7,000.

A very significant difference compared to earning €25,000 out of €32,000.

In any case, no one can deny that the 2000s were not the best period to invest.

In the graph above, we compare the lost decade (in blue) with the decade from 2010 to 2020 (in red). The comparison is clearly favorable to the latter decade, with a cumulative increase of 146% versus 23%.

As we see in the table above, an investor with the same plan (investing €10,000 each year) would have obtained an APR of 11% between 2011 and 2020.

Much higher than the 5% mentioned above.

This tells us that there are clearly periods (or decades in this case) that are better for investing than others. But it’s impossible to predict this in advance.

Furthermore, if it’s already difficult to predict what will happen in a year, how can it be possible to predict what will happen in a decade?

That’s why the recipe of continuing to invest no matter what remains valid, even taking into account the variability in market returns over time.