The market has been dropping like a rock. It's probably safer to keep your money in cash until things start to recover, right?
On the surface, that seems logical, but the data doesn't support it. Half of the best trading days in the market's history have taken place during bear markets, so sitting on the sidelines, while it might feel smart, can actually cost you dearly.
Let's unpack why.
Image source: Getty images.
Prices are cheap
While price is not everything, one surefire method of making money in the stock market is to buy stocks when they trade below their intrinsic value. Logically speaking, the best time to find these opportunities is when the market has shed billions (if not trillions) in value.
When investors shift to a risk-off approach, they tend to throw the babies out with the bathwater. This creates a massive opportunity for patient investors to scoop up shares of the great businesses others are selling.
Microsoft (MSFT +3.64%), for example, is down almost 25% from its all-time high. This is a company that has been a top-two leader in cloud services for the better part of a decade and has grown its earnings at a compound annual rate of 17% since fiscal 2014.
From a valuation (price-to-earnings) standpoint, the last time Microsoft was priced this cheaply was March of 2020, and the last time the share price was this low was June of 2021. Just ask yourself: Has Microsoft improved as a business since those two periods? If you believe so, it certainly looks like a buying opportunity for this company.
For more risk-tolerant investors, there's significantly higher upside in smaller companies like PubMatic (PUBM +2.13%).
This sell-side ad technology platform has a market cap under $1 billion, and it has seen its stock drop over 50% year to date. The sell-off is indicative of a struggling business, but the company's most recent earning report paints a different picture. PubMatic grew its revenue 25% in the first quarter and boasted a net dollar-based retention rate of 140% for the trailing 12 months. In other words, customers are not only sticking around but also increasing their spending.
Due to the recent pullback in tech stocks, this hyper-growth company is trading at a very reasonable price-to-earnings ratio of 17, which is below the average for the S&P 500.
Stocks don't wait for good news
Many investors wait for optimistic headlines to start putting their money back into the market. The problem with that is the stock market hasn't historically waited for the economy to begin recovering before moving higher.
While it might seem counterintuitive, half of the best trading days in the market's history have taken place during bear markets.
And missing out on the best trading days has massive effect on long-term returns. Consider the S&P 500's return by decade with and without the 10 best trading days of each 10-year span:
|
Decade |
Return |
Return When Excluding 10 Best Days of the Decade |
|---|---|---|
|
1930 |
(42%) |
(79%) |
|
1940 |
35% |
(14%) |
|
1950 |
257% |
167% |
|
1960 |
54% |
14% |
|
1970 |
17% |
(20%) |
|
1980 |
227% |
108% |
|
1990 |
316% |
186% |
|
2000 |
(24%) |
(62%) |
|
2010 |
190% |
95% |
Data source: Bank of America. Table by author.
In case the takeaway isn't clear, by missing just the 10 best days in a decade, you could be missing out on the bulk of your returns.
If we know that 50% of the best trading days occur during bear markets, the real question shouldn't be, "Should you invest in stocks right now?" but rather, "What is the cost of not investing?"
Shifting your mindset
Changing your mindset can do wonders for your portfolio during bear markets. Many investors hide in cash, because they're focusing on the price points of stocks they bought at the top.
That's a flawed way to look at the market. Nobody knows how long it will take for stocks to regain their all-time highs or if some individual stocks will ever fully recover. But what we do know is that all 27 of the previous bear markets have recovered at some point, and the ensuing bull markets have, on average, lasted much longer.
Instead of focusing on the stocks you're underwater on, think about your return potential at current prices. This is the best way to recoup losses in your portfolio.
There's money to be made in bear markets
So being a net buyer of stocks through a bear market is the most effective way of surviving and eventually thriving until the next bull market.
If you're waiting around for clear signs the market is heading toward bull territory again, don't expect to make much money investing.
It's easier to just take the guessing out of the equation and invest regularly. You might not buy at the bottom, but you will be getting good deals leading up to the recovery.
If you feel confident enough to know when the 10 best trading days are going to happen this decade, by all means stay out of the market right now. But for me, I'd rather play it safe and keep investing a portion of my money each month.
