Downturns in financial markets are a troubling part of investing. Whatever you do, it’s best to take steps to plan ahead for a market drop. during A sale is also very important. It is unrealistic to avoid losses entirely, especially for stock investors. But individuals sometimes make decisions that cause avoidable financial losses. Here are three ways to reduce the risk of unnecessary, self-harm in a declining market.
single stock ≠ stock market
You’ve heard of it before: past performance is not indicative of future results. It’s just not legal – it’s true – and the chart below shows why. this point. After years of strong performance…
…both new publicly traded stocks and legacy stocks suffered dramatic declines. Compare these disadvantages with the Russell 3000 and suddenly the stock market does not appear He bad.
For single stocks, dips like this are not uncommon. According to JP Morgan, between 1980 and 2020, roughly 45% of stocks in the Russell 3000 fell 70% or more from the previous peak and never recovered. Almost flip a coin.
Make no mistake, investing in a company (perhaps from employer stock options) can yield potentially huge returns far beyond a diversified index. The problem is that investors don’t properly size their risk, don’t understand their exposure, or don’t know when they’re going to make a profit.
Checking your accounts can do more harm than good
One way investors incur unnecessary losses is to check their portfolios during market downturns. To illustrate, the chart below shows the one-year total returns for the S&P 500. The purple line shows: daily orange line reporting gains and losses monthly.
Both have the same net result.
But if you were checking your account every day, share more ups and downs to deal with. The wild fluctuations in the market will at best stress you out and at worst cause you to make hasty investment choices that can hurt yourself.
So if you’re not planning to make a change, what’s the point of looking? If there is a reason to trade, make sure that the innovation bias does not affect the decision.
chasing the market
It can be tempting to make changes to your portfolio after recent events. Looking at various stock indices for company size and factors, there is little correlation between the best or worst performers in the past month or year and longer periods. In fact, recently, the result has been reversed.
The one-month return and value of the small equity, high dividend and defense sectors are particularly striking. Yet seven years later, these indices are the worst performers. Does this mean you shouldn’t have investments with these characteristics in your portfolio? Number! It just shows the importance of diversification. Markets are cyclical.
If you’re looking at your account on a daily basis, it can be tempting to sell the losers and chase the winners. This can have lasting effects. These charts also highlight the downside of tax loss harvesting. Harvest losses for tax purposes only can have wider implications due to wash sales rules.
If you sell an investment at a loss, you cannot repurchase the position (or a substantially similar position) for 30 days. So you will either buy something you don’t like very much or stay in cash. The market can move significantly during this time – the above four indices are gaining over 10% in one month.
This is not an anomaly either. Since 1928, the S&P 500 has averaged 15.2% returns in the first month of a bull market, according to Bespoke Investment Group. Average earnings rise to 31.6% in the first 3 months. No one can predict what the market will do from the 2022 bear market, but historically, markets move fast and the best days in the market often fall into a week or two from the worst.
Silver plated! Market changes can bring opportunities
changing market conditions, all bad news. Rising interest rates have been very bad news for stocks, bonds and homebuyers. But for those with the cash, it’s a big win. One-year Treasuries are now 4.75% compared to 0.17% a year ago (November 2021)… That’s an increase of 2,700%! Investors can build a Treasury ladder or buy longer terms to lock in the yield.
Even high-yield savings accounts yield good cash returns. While you can enjoy a safe 3% APY in the right savings account, there is no reason to park loads of cash in a 0% checking account that earns no interest.
However, not recommending individuals abandon their portfolios and buy Treasures! But for some investors, the returns are attractive enough when Treasuries should be part of the conversation when considering allocating a new cash investment.
It also highlights the nuances in investing and why a few things are black and white. Just because you don’t check your account every day doesn’t mean you don’t check at all. And a passive buy-and-hold strategy should not ignore rebalancing needs, the opportunity to harvest the right tax loss, or periodic fund assessments.
In down markets, there is a tendency for people to want to take action. To do something to stop losses. Acting on this impulse is often (though not always!) an unwise decision. It is also perhaps the most common way investors who manage their own portfolios incur avoidable financial losses.
¹ Highest percentage of total returns, Russell 3000 decline roughly -22% to 11/3/2022. The Russell 3000 represents roughly 97% of the US stock market.