Market falls: what history actually shows

Every long-term investor will experience several substantial market declines, and knowing what they typically look like is better preparation than any reassurance.

What the record shows

Broad patterns rather than precise figures.

Declines of around ten per cent occur frequently, historically around once a year on average in major equity markets.

Declines of twenty per cent or more occur every several years.

Declines of a third or more have occurred multiple times within a typical investing lifetime.

Recovery times have ranged from a few months to, in the most severe cases, many years — and in some markets, considerably longer.

Which means the experience of investing over decades includes several periods that feel like a permanent loss at the time.

The recovery point

Which is where the evidence is most useful.

Studies examining the effect of missing the best days in the market consistently find that a small number of the strongest days account for a large share of long-run returns.

Those days cluster around the worst days, during periods of high volatility.

Which means an investor who sells during a decline and waits for calm to return frequently misses the sharpest recovery.

The corollary — that missing the worst days would improve returns even more — is also true and is not actionable, since the two cannot be separated in advance.

Why selling feels correct

The psychology.

Losses are experienced more intensely than equivalent gains, which is one of the most robust findings in behavioural research.

Recent events are weighted more heavily than distant ones.

Falling prices generate news explaining why they will continue.

Other people selling provides social confirmation.

And doing something feels better than doing nothing, particularly under stress.

All of which produces a strong and coherent-feeling impulse to sell at exactly the moment when selling is most damaging.

The plan written in advance

The most effective protection.

Writing down, while calm, what you will do in a decline of twenty, thirty and forty per cent, and why.

Including the reasoning, so that the future version of you reading it understands the logic rather than only the instruction.

This is a commitment device, and the evidence on commitment devices in other domains suggests they work.

It also converts the question during a fall from "what should I do" to "what did I decide", which is a considerably easier question.

What to actually do during a fall

Practical.

Continue regular contributions, which buy more units at lower prices — this is the mechanical benefit of automated investing.

Rebalance if the allocation has drifted beyond the threshold, which mechanically involves buying what has fallen.

Check that your short-term money is still in cash and untouched.

Reduce the frequency of checking the portfolio, since research finds that more frequent evaluation increases the perceived risk and the likelihood of selling.

Avoid financial news during the period, which is optimised for engagement rather than for your outcomes.

And do nothing else, which is the hardest instruction.

When selling is reasonable

For balance.

If the money is genuinely needed within the horizon, which indicates it should not have been invested.

If the allocation was wrong for your capacity for loss, in which case reducing risk after a fall is painful and may be correct — with the recognition that this crystallises the loss.

If your circumstances have changed materially.

And for tax purposes in specific situations.

What is not a reason: a forecast, a headline, or a feeling that this time is different.

The phrase to be wary of

Worth naming.

"This time is different" is the standard formulation at both market peaks and market bottoms, and it is occasionally true and usually not.

Each decline has a specific cause that appears unprecedented at the time, and each previous decline also had one.

Which does not mean markets always recover — some national markets have taken decades, and individual companies fail permanently.

It is an argument for broad global diversification rather than for confidence in any single market.

The realistic expectation

Which is worth internalising.

Investing over decades involves periods of substantial paper loss lasting months or years.

The long-run averages quoted in prospectuses conceal this entirely.

An investor who expects this and plans for it behaves quite differently from one who does not, and the difference in outcome is generally larger than any difference in fund selection.

General information only, not investment advice. Investments can fall in value and past performance does not indicate future returns. Consult a regulated financial adviser.