By Stacy Francis, CFP®, CDFA
When your account balance drops, it can feel personal, like you “did something wrong.” But market downturns are part of investing. The real question isn’t whether your portfolio ever turns red. It’s what you do next.
In volatile moments, many investors wonder: Should I get out? Should I wait? Should I jump in now? The truth is, none of us can predict the perfect moment. What we can do is build a decision process that keeps fear and hype from making the call.
This guide is your calm-plan: how to evaluate whether to hold or sell and how to stop emotion-based decisions from sabotaging returns.
Should I stay invested during market volatility?
When the market is in transition, it’s tough to decide whether to be in the game or on the sidelines. But worried money sitting in a checking account never makes money. And if you’re waiting for certainty, you may wait forever.
Since neither of us has a crystal ball, the best way to prepare for the future is to invest in it. Certainly it’s better to have money working. The best bet for the future involves investing in a diversified portfolio of stocks and bonds. By spreading out your investment portfolio, you usually can reduce risk, minimize losses, and take advantage of the next “surprise” winners.
READ: How to Start Investing in the Stock Market by Ann Wilson
How to decide whether to hold or sell after a decline
When investment accounts are in the red, many people may think “I can’t sell because my investments are all down, but they just keep falling. It’s a total nightmare.” One of the most common investing mistakes is refusing to sell something simply because it’s down from where you bought it. That’s loss aversion, and it’s powerful. Here’s a helpful reframe:
Holding equals buying. Every hour, every market day, you choose whether you like your investment, or not. Whether your investment is up or down from where you bought it is irrelevant, as the past has no meaning when it comes to investments. It doesn’t (or shouldn’t, anyway) matter whether the stock you own that is trading at $5 per share was $1 last week, or $30.
If you would buy it at today’s price, you should hold it. If you wouldn’t buy it at today’s price, you should sell it. It is all about what the price is now, and what you–or the people you trust for advice–think it is going to be in the future.
How do I know it’s time to give up on an investment? Ask yourself:
- Do I still believe in this investment for the long run? No matter what your reason was for buying the security in the first place (you were bullish on this industry, you share the company’s values, you adore the business model, you like the fund manager’s expertise and performance, etc), if you lose this reason, you need to lose the investment.
- Have the fundamentals changed—or is it just the market being the market? Has anything material changed about the company/fund/strategy? Both the economy and the markets go through cycles of ups and downs. If the company of your choice is truly great, sooner or later your investment will pay off.
Don’t let your purchase price be the reason you hold. Be clear over the reasons for your investments, and use them to determine not only when to get in, but also when to get out.
READ: How to Think About Picking Individual Stocks by Stacy Francis, CFP®, CDFA
The problem with following your gut (and trying to time the market)
A client once told me that she always listens to her gut when determining when to buy and sell. It had never been wrong in any other aspect of her life, yet she kept losing money.
The issue wasn’t her intuition; it was using feelings to time the market.
Intuition is useful in many parts of life. In investing, it often backfires. Your gut’s job is to keep you safe. When markets get shaky, it screams “get out.” When prices rise and everyone feels confident again, it whispers “okay, now it’s safe.”
The problem is that this pattern leads many investors to sell low and buy high—the opposite of what they want. Statistics show that it is not unusual for investors who move in and out of the markets to underperform major indexes by about 1.5 percentage points.
I’m not saying you should ignore your gut, because it is useful in so many other aspects of life. Sometimes, it can be a lifesaver! But when it comes to investing, it’s all about the rationale. Draft a long-term strategy, stick to it, and–with the exception of your annual or bi-annual portfolio review–leave your money alone.
Avoiding the trap of performance-chasing
Emotion-based decisions can derail your results, especially when they push you to chase performance or try to pick winners. Even experienced investors can get pulled into cycles of greed and fear—chasing hot trends, then panicking when the story changes.
The classic example: In the tech bubble of the late 1990s, investors poured their money into technology stocks for easily gotten gains and took risks they should have avoided. We all know what happened soon after. The tech bubble burst and fear clouded the judgment of tech investors as they dumped these stocks like hot potatoes (and a few even avoided owning stocks at all).
Numbers speak for themselves. According to SPIVA Scorecards, 88.3% of large-cap funds underperformed the S&P 500 over the last 15 years.
Fear and greed are natural human emotions. However, when it comes to investments these emotions often cause us to make decisions that are not in our best interests over the long-term. Investment decisions should be made with clarity and conviction.
How to stay calm through the market ups and downs
- Create an Investment Plan. Decide upfront what percentage of your money should be in stocks versus bonds (asset allocation), and within stocks, how much in large companies versus small companies and how much in growth stocks versus value stocks. You should also be sure to invest in international and domestic stocks (diversification). Learn more about this in our investing guide.
- Stick to Your Plan. Once you decide on how to divvy up your money, don’t change your plan unless your objectives change and you are going to need the money in the next three years. Examples of a shift in objective could be a home purchase or you are nearing retirement. Don’t make changes from panic when markets are down.
- Rebalance Your Portfolio. Many investors are burned because they make an investment and forget about it. Be sure to rebalance your portfolio every year. Why do you need to do this? If you are hoping to have a break up of 40% bonds and 60% stocks in your portfolio you need to check that you have the same percentages. It is natural that stocks will grow faster than bonds over the long-term. Most likely you will be over weighted in stocks in several years if you do nothing.
A diversified plan and a steady review cadence help prevent emotional decisions from becoming permanent damage.
READ: Protecting your Portfolio Through Life’s Ups and Downs by Susan Hirshman
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