Don’t trust your gut, at least when it comes to falling stock prices.
Your natural response to a massive sell-off may be to “do something,” especially since so much of your wealth, and ability to comfortably retire, is tied to the returns of various investments, including stocks.
And it’s easy to get lost in the hysteria. Stocks fell sharply on Wednesday, with the Dow Jones industrial average and the S&P 500 erasing their gains for the year.
Still, responding to market volatility by selling stocks is hardly ever a good idea. Here’s why.
Investors tricked into action
Investors have this nasty habit of buying high and selling low.
In 2016, for example, the S&P 500 gained 12 percent — a healthy return for a bull market as old as this one. You must have made out nicely, right? Well, not so much.
The average stock mutual fund investor, according to the latest Quantitative Analysis of Investor Behavior report by market research firm DALBAR, gained only 7.3 percent. That’s a pretty sizable gap. What’s going on?
Well, according to DALBAR, investors trailed significantly in January, then again in November and December. January was when stocks got off to their worst performance start to a year ever thanks to slow economic growth in China. The end of the year dovetailed with the so-called “Trump bump” in stock prices, despite analysts predicting Armageddon should Trump actually make it to the White House.
Basically, investors got psyched out by the news and made bad bets on what that news would mean for stock prices.
Losing is painful
Reacting to market ups-and-downs belies what financial planners tell you to do. Stock prices will rise and fall, but they’ll mostly gain over the long haul. The only way to profit off long-term returns is to keep your money working for you, even when the sky looks like it’s falling.
Part of the problem, according to William Bernstein of Efficient Frontier Advisors, is that many investors overestimate how much of a loss they’re willing to endure.
He has an illustrative graphic in his book, “Rational Expectations,” that shows people are more apt to trash their carefully crafted financial plan as losses mount. It just doesn’t feel good to see the value of your accounts get smaller.
What to do
The easiest answer, then, is not to do anything. Well, maybe turn off the television, silence your phone and go for a walk.
Presumably you’ve allocated a certain percentage of your assets into stocks for a reason, and that reason shouldn’t change because of a series of short-term drops. Talk to investors who sold at the market bottom in March 2009 and missed out on the subsequent recovery. Equities are riskier than bonds, which are riskier than money market accounts, so you should expect bad things to happen every now and then.
Doing nothing, though, is hard. We’re human, and humans get nervous when green numbers turn into red ones. It might be unrealistic for you to expect yourself to do nothing.
If you’re the type of investor with an itchy trigger finger, you may have more risk in your portfolio than you’re comfortable holding. Consider shifting into an all-in-one balance fund — perhaps one that holds a mix of stocks, bonds and some cash.