Scared investors have a tendency to duck and cover when the stock market experiences a significant decline. The temptation is strong to hide money in fixed-rate investments and to wait the decline out. The trouble with this strategy is that investors who don’t have perfect foresight run the risk of missing out on the relatively swift recoveries that market makes.
There have been 14 major declines in the market of 15% or more since 1950, says David L. Babson & Co., an investment advisory firm. It has taken an average of 13 months for the stock market to recoup 100% of its losses from the low points reached at the end of those declines, Babson says. It took an average of only 7 months for the market to regain 75% of its losses, Babson adds. During the first seven months after a major decline investors are likely to remain shell-shocked and in hiding. This prevents them from recovering their losses quickly. “The norm is a fairly quick rebound, then a climb to higher peaks,” the company says. “As no one can tell when that will be, investors are likely to do worse by being out of the market than in it.”
Generally, deeper declines can mean longer recoveries, such as the 22-month recovery period after the loss of 37% in the period 1968-70. The major exception was 1973-74, when the market fell 48% and took 64 months to recover. Babson says inflation was accelerating at a rapid rate during that period. ?As that process continued in the next seven years, it drove bond yields into the stratosphere and halved price-earnings ratios,” Babson says. “That was wholly exceptional.”
