After a decade-long bull market, most investors anticipated some sort of market decline in their future. But that doesn’t make the COVID-related volatility of the past couple of months less painful.
Unfortunately, many investors respond to downturns in irrational or financially harmful ways—and make decisions that could potentially cause even more damage to their investments. Here are the most common mistakes that investors facing a down market make—and how to avoid them:
1. They Don’t Have a Plan
All investors should have a solid plan for their investments that incorporates their time horizon, risk tolerance, and financial goals. Creating one provides a roadmap for what to invest in and when—but more importantly, it also provides guardrails for how to respond to dramatic market downturns. For instance, if you’re saving for retirement and you’re more than a decade away from needing your funds, then you can take comfort in knowing that your equity investments have time to recover. Don't have a plan in place? Don’t panic—instead, meet with your advisor and create a framework for your investments that can make your overall efforts more strategic and less reactive.
2. They Buy High and Sell Low
Of course, this is the opposite of what investors plan to do. But downturns (and peaks) cause investors to do irrational things, which is why buying high and selling low is a common mistake. During peaks, investors are often wooed by stocks that are overperforming, and they believe that if they don't invest now, they'll miss an opportunity. Then when markets drop, many of the same investors apply similar thinking—they try to ditch an underperforming stock before it loses even more. The trouble is that throughout the course of history, markets regularly move up and down. If you always sell at signs of trouble, you effectively solidify your losses. You also increase the chances of missing any sort of recovery when it does happen.
3. They Forget to Rebalance
Market moves naturally shift portfolio allocations, with market highs leading to overweight positions in some asset classes and downturns yielding underweight positions in others. Left unattended, these shifts can significantly alter your portfolio, leaving you with investments that are misaligned with your goals and primed to underperform. After downturns and peaks, rebalance your portfolio back to the allocations that work with your investment strategy. By doing so, you’ll ensure that you don’t unintentionally have more risk than you need or conversely, have too conservative of a portfolio when the market returns.
4. They Try to Time the Market
A 2019 study by Morningstar notes that “timing is the bane of investors everywhere.” Very few investors—from novice to professional—are skilled at timing the market. The Morningstar study notes that the average investor lost 45 basis points over the five, 10-year periods that ended December 2018. That may not seem like a loss, but the report authors contend that while 45 basis points were the average, the bottom 5% to 10% of investors experienced exponential losses due to poor timing. Downturns may tempt investors into trying to time the market to capitalize on certain asset classes or broad market moves. But doing so is exceptionally risky. And it’s more apt to hurt the average investor than offer a strategic boost.
5. They’re Short-Sighted
A volatile market and the specter of a recession can certainly cause a lot of sleepless nights. But by focusing on the near-term, especially when you have a long investment window, you introduce a lot of stress and worry. Instead, take the long view of a downturn. Consider that the average bear market lasts 1.4 years, while you may have years or even decades on your side. Keep your sights on your end goal and hold your ground, even when it feels a little unsteady.
6. They Focus on the Wrong Thing
During a market downturn, it’s easy to keep checking and rechecking your investment performance—and focusing on the losses. But doing so is unproductive and potentially risky. Market downturns are part of the expected market cycle, especially after the longest bull run in the market’s history. In addition, while no one seeks losses, they do play a role in your portfolio, and many investors use them to offset gains and limit their capital gains taxes. Your portfolio is a living investment that remains in flux—and as noted above, the key ingredient is time. Keep that in mind, and don't obsess over losses. That said, if your portfolio is causing you too much stress, then talk to your advisor about a more conservation allocation or lower-risk investments.
7. They Let Emotions Drive Decisions
Emotions and investing don’t mix well, especially during downturns. Dramatic dips can cause investors to panic—and then make fast and ill-advised decisions. If your emotions get the best of you, find ways to implement some barriers between you and your investments so that you can’t take action on a whim. For example, you might consider actively managed funds, which often require you to make contact with a person before changing an investment. You can limit triggers that cause stress, such as checking your investments repeatedly. Also, schedule calls with your advisor during downturns to talk through a plan; instead of simply reacting.
Market downturns aren't ideal. But making mistakes during them can take a tough situation and make it that much worse. Keep your perspective on the long-term, manage your emotions, and don't let a focus on the now impede your success later.