Investing money could help you grow your wealth, but it isn’t always a smooth path. You should prepare for all investing scenarios, including inevitable market pullbacks.
As an investor, market declines can feel overwhelming. It’s difficult to see the money you worked diligently to invest drop in value. Unfortunately, it’s a part of investing that happens regularly. Sometimes markets drop only a few percentage points. Other times they fall 10%, 20%, or even more.
In an ideal world, you’d stick to an investment plan you drafted when you initially started investing. Market declines can mess with your head, though, and result in rash money moves that do anything but help you thrive in an uncertain economy. You can work to avoid these money mistakes if you’re aware of them.
15 money mistakes people make during a market decline
It’s easy to panic if you see the market drop quickly. During the early days of the coronavirus pandemic in 2020, the S&P 500 index dropped roughly 35% in a little over a month. Panicking at these times typically won’t help you. Instead, consider taking measured action, which could mean taking no action at all.
The key is having a financial plan. Your plan should tell you how you should react if the market drops drastically or makes any other big moves. Stick to your measured plan for the best chance at reaching your long-term goals. If you don’t have a plan, craft one today. This way, you won’t be caught off guard by the next market drop.
Rebalance out of fear
Rebalancing a portfolio, where you sell investments you hold too much of to buy more of assets you don’t have enough of, isn’t necessarily bad. What could hurt you is rebalancing out of fear. Your financial plan should state at what point you need to rebalance. For instance, you may decide to rebalance when your allocations deviate more than 10% from your target allocation.
Based on this example and a plan that calls for a 50% allocation to stocks and 50% allocation to bonds, you’d need to rebalance if stocks or bonds exceeded 60% or made up less than 40% of your portfolio. The key is researching when it’s smart to rebalance for your situation and planning to do so when you reach that point.
When you see your investments rapidly decreasing in value, it’s natural to want to hold onto what’s left and sell everything to take advantage of the remaining value of your portfolio. During market turbulence, it often feels like things won’t get better. Historically, that hasn’t happened yet.
The stock market is still reaching all-time highs in recent months. And although the future can’t be predicted by the past, selling everything usually isn’t a smart move in hindsight.
Forget their investment strategy
When you picked your investments, there was a reason you decided to invest in them. That strategy is key to building wealth through investing. People tend to focus on the loss of wealth when markets decline, not the future potential of the positions they hold.
When markets are falling, go back and reread your investment plan and strategy. It should remind you why you’re invested and help you stay invested for the long term. Make sure to update your plan regularly so you aren’t caught in a bad spot the next time a downturn happens. This way, you can make adjustments when they make more sense.
Obsessively track their portfolio
Many investors invest for the long term. They want to have enough money to retire or reach other goals down the line.
In general, watching your portfolio tick up and down every day won’t help you reach those long-term goals. You have to stay invested and keep investing to reach them. Checking your portfolio daily or even many times per day only adds anxiety to your life as the market swings. It doesn’t help you make rational long-term decisions.
Closely follow market-related news
Just as watching your portfolio daily won’t help it reach your long-term goals any faster, watching market-related news all day won’t, either. It’s important to stay informed, especially if you’re performing an annual review of your investments.
You can do this without taking part in the 24-hour news cycle, though. Find a publication you trust and read its market updates. Market-related news that doesn’t impact your investment plan can add emotion that opens you up to deviating from that well-thought-out plan.
Hyper-focus on the short term
People focus on long-term trends when looking at the history of the stock market. Within those long-term trends, you can find many short-term events that seemed like they could significantly impact investment returns going forward. However, the market still hits all-time highs on a reasonably regular basis.
Short-term events can and do impact the market. That said, they tend to even out over more extended periods. Don’t get worked up over small events that may end up working themselves out. Instead, follow your investment plan to keep on track with your goals.
Lose sight of the long term
When these short-term events happen, it’s easy to get fully consumed by them. How can investments continue increasing given this current problem? Thankfully, the world is a resilient place.
It’s hard to remember that in the dark days of a serious market decline. Even so, the long-term trend of increasing investment prices has held for well over a century. As we said earlier, that could always change, but focusing on the long-term average stock market returns should help calm your nerves in a short-term panic.
Try to time the market
When you have a strong feeling that this decline is different, you may want to try to time the market. After all, you could increase your long-term investment returns if you can sell now and avoid a further 20% loss.
The problem is timing the market requires you to time two actions perfectly. People rarely get both right. First, you need to sell before the bottom. Then, you need to buy back in at a lower point before the market starts increasing again. If you miss either of these points, your returns could suffer.
Stopping contributions when markets fall might work against your long-term investment strategy. As prices decrease, you can purchase more of an investment with the same amount of money.
An example makes this clear. You might invest $500 per month. In a month where your investment costs $100 per share, you can buy five shares. When the price decreases to $83.33, you can now buy six shares. If it drops to $71.42, you can now buy seven shares. As long as the investment eventually returns above the initial $100 price, you end up ahead. In this case, let’s say the investment price hits $110 after a year. The 18 shares you bought cost you $1,500 but are now worth $1,980.
Blame their financial advisors
Financial advisors often get heat when the markets decline. Investors pay financial advisors to help them invest, but some people have the wrong idea. Financial advisors don’t have a crystal ball to help their clients avoid every downturn.
Instead, advisors should help you build a solid financial and investing plan. Then, they should help you stick to your plan when markets decline. They can’t change the markets, but they could help you avoid common money mistakes people make during declines to help provide more stable long-term returns.
Take advice from non-experts
When markets tumble, everyone has an opinion about investing money. Your coworker might have a hot stock tip to help you get rich. Your parents could move their investments to cash to try and preserve what’s left for a pending retirement.
It’s best not to take advice from non-experts, though. You don’t know the person’s entire financial situation. Chances are, they’re in a very different place than you. They may have alternative motives too. Instead, it's probably best to stick to the advice given by a financial expert who takes your whole financial situation into account.
Forget that declines are inevitable
Although the long-term market trend results in increasing investment prices, declines happen regularly in the stock market. CNBC and Goldman Sachs found that there have been more than 20 market corrections where the market drops 10% or more since 1946. On average, that means they happen at least once every few years.
Investing in a recession could prove to be very beneficial. With this knowledge, you can prepare for these declines and plan how you want to handle them. This way, you can make decisions based on logic rather than emotion when the time comes.
Break their budget buying stocks
Long-term investors might see market declines as an opportunity to pick up investments on sale. If you purchase investments and they decrease more in the short-term, it’s tempting to want to buy even more at an even better deal. Unfortunately, this mindset can get dangerous quickly. If you keep buying more as the market decreases, you may end up overextending yourself.
If a market decline coincides with a need for cash in your personal life, such as a job loss, you may find yourself having to sell your investments to cover your living expenses. This could result in an unintended loss that could have been avoided by sticking to your investment plan.
Not considering tax consequences
People usually buy investments over years or decades. If the market declines 10% from the recent high, there’s a good chance the same assets are still worth more than when you bought them.
If you sell during the decline, you realize the gains from those investments. In some cases, you may have to pay taxes on those gains. Carefully consider the tax impacts of unloading your investments based on emotion before you hit the sell button.
The bottom line
History shows declines in the markets happen regularly. Be prepared for those declines by coming up with an investment plan that details what you want to do with your portfolio when the next slide starts. For most people, the plan may require staying the course to take advantage of long-term investing trends. Others may need to take specific actions.
If you’re unsure how to build your financial plan, consider consulting with a fee-only fiduciary financial advisor. These professionals can help you develop an investment plan based on your goals and circumstances.