4 Big Mistakes Investors Make When the Market Is Dropping — And How To Avoid Them
Written by
John Csiszar
Edited by
Amber Barkley
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Over the long run, the stock market moves based on earnings. But over the short run, it’s a much more emotional mechanism.
When markets race higher, many investors chase prices as they become more confident. But when the market sells off, fear is often the dominant emotion. In that type of environment, it’s easy to make bad decisions that lead to poor investment results.
The key to success is keeping emotion out of the equation, and that can be easier said than done. But forewarned is forearmed. Here are some of the most common mistakes that investors make when markets are falling and steps you can take to avoid making them.
Panic Selling Everything
It can be hard even for the bravest investors to hold on to their investments when they are down 20%, 30% or even more. But corrections and bear markets are a natural and regular part of investing.
On average, a correction of 10% or more occurs about once per year, while bear markets, defined by a drop of 20% or more, happen about every four years. But here’s the thing — no matter how far the market has fallen in the past, it has always gone on to make new highs.
If you panic and sell everything you own when the market is down, you will miss the inevitable bounce-back. In fact, historically speaking, the biggest market rallies typically occur during or after bear markets, according to CBS News.
What To Do
Blindly selling everything you own when the market is down is a sure-fire way to miss some of the biggest gains the market has to offer.
Getting back in at the exact market low is highly unlikely, so it’s usually best to hold on and ride out the selloff until the bull market returns.
Not Selling the Right Stocks
While blindly selling all of your stocks during a downturn is a mistake, not selling the right ones can be an even worse choice. Although the overall market has always recovered from a bear market, the same cannot be said for individual stocks.
If some of your stocks are down because of their own fundamental reasons rather than general market malaise, they may deserve to be sold, as they may not come back.
What To Do
When stocks are down, do your research and find out why. If earnings are slowing, management is ineffective or trends are working against a company, it may be time to sell them, even if they are down.
Turning Off Automatic Contributions
One of the best ways to invest for the long run is to set up automatic transfers from your bank account to your investment account(s). But some investors can feel like they’re throwing money away when the market goes down every month and their automated contributions immediately lose money.
Turning off automatic contributions, however, would be a mistake. Although it can be painful to watch, your automated contributions will be buying more shares of stock when the market is down, lowering your average cost and amplifying your gains when markets recover.
What To Do
Stick with your automatic contributions during corrections and bear markets.
Failing To Rebalance
If you have a diversified portfolio, even in a sharp market selloff, it’s likely that a portion of it will be up, or at least not down as much. For example, so-called “defensive stocks,” like consumer staples, typically perform better than the broad market during corrections, and bonds often go up in value.
Over time, these differences in performance may lead to an out-of-balance asset allocation.
Using a simple example, if your original portfolio allocation was 60% stocks and 40% bonds, during a market selloff, it may shift to 50% stocks and 50% bonds. If you fail to rebalance, your portfolio won’t have the same risk-reward characteristics going forward.
What To Do
Rebalance your portfolio during a market correction so that you can keep your portfolio in line with your objectives. This will also allow you to take profits on the outperforming sectors of your account while reinvesting in investments that are down in value.
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