How many times over the last year have you checked your investment account, saw a sea of red and considered selling your stocks?† It’s understandable in a year when the TSX Composite index is fluctuating by as much as 12% and the S&P 500 is down 24%.
In investing, it’s important to take the long view. The S&P 500, for example, has consistently returned 6.5% to 7% annualized after inflation since around 1800, according to research firm McKinsey & Company. That’s why stocks remain an important part of a balanced portfolio. There are simple ways you can improve your buy and sell decisions – and position yourself for the long term returns that have rewarded patient investors through the years.
Here are six things to consider to help you make better decisions:
1. Always take the long view
If you tend to worry (about investing or life in general), you’ve probably heard that one way to control your fear is to ask yourself if it will matter in one year, three years or five years from now (the answer will likely be no).
If you’re worrying about your portfolio now, the same rule applies and there are numbers to back that up. Consider this – since 1950, every time the S&P 500 has been down 25% or more, it has gained within a year. That trend holds true on the three-year, five-year and 10-year periods following the initial 25% decline – though sometimes corrections do take longer, as was the case following the 2008-09 financial crisis.
The takeaway: If you’re patient through market fluctuations, you have a strong chance of seeing your portfolio rebound in the short, medium and long term.
2. It’s easy to time your sells – but near impossible to time your buys
If you’re tempted to try to time the market bottom, consider this: the research shows investors who try to time the market almost always lose – instead of buying low and selling high, they end up doing the opposite!
That’s because, while it might feel good to sell in a decline and watch as stocks fall further, all too often the market quickly bounces back past the investor’s selling price, then surges further, forcing them to buy back in at a higher level.
The bottom line is that timing the market almost never works, and when it does, it’s usually more due to luck than anything else.
3. Don’t “fall in love” with your investments
Instead of being quick to sell, some investors hang on to flawed investments for too long, hoping they’ll eventually turn the corner. It’s a virtue to buy a top-quality stock and hold it, but sticking with troubled companies – whether it’s a dramatic shift in their industry, management turmoil or accounting issues – will increase your risk.
Consider investors who bought “stay-at-home” stocks, such as sellers of exercise equipment and videoconferencing platforms, and held them as COVID-19 lockdowns became commonplace. But once economies reopened, these companies’ businesses shifted, and their stocks fell. Buy-and-hold investors were there for the trip up – and back down.
The best way to avoid “falling in love” with your stocks is to remember why you bought them in the first place – and constantly measure them against that yardstick.
For example, say you bought a stock because its price-to-earnings (P/E) ratio was below that of the market, so you considered it a bargain at the time. If it has since soared so that its P/E is above that of the market, you should consider selling at least part of your position.
4. Remember that no two market crises are the same
Many investors suffer from “recency bias,” where they judge the current crisis in the same light as the last one. For example, you’ve likely heard comparisons between today’s inflation and that of the 1970s. And when stocks crashed during the initial wave of COVID-19, comparisons with the 2008-09 financial crisis abounded.
But as we’ve seen this past couple of years, no two market events are the same, so we need to be careful not to let past crises colour our judgment of the current one.
This applies to statistics, as well. Take the market’s tendency to post positive returns after it crashes 25%, as discussed in the first bullet above. That’s a pattern that’s worth paying attention to, but do remember that there’s a random element to statistics like this, and this time may indeed be different. This is why sound portfolio-management principles, like ensuring you’re properly diversified and knowing your risk tolerance, are key.
5. Manage your risk with dollar-cost averaging
Dollar-cost averaging, or investing a fixed amount of money in stocks at fixed intervals, is a proven way to mitigate risk. By doing this, you’re naturally buying more stocks when prices are low and fewer when they’re expensive.
For example, let’s say you bought $1,000 of Stock X at the end of every month, its price ranged from $20 to $40 throughout the calendar year, and it traded at the high end of that range on December 31. Your average purchase price would have been around $30 – less than what you’d have paid if you waited until the end of the year to make your purchase.
Right now, with the market down double-digits for 2022, could be a good time to start a dollar-cost averaging program if you haven’t already done so. Consult with your advisor to make sure you’re focusing on the investments and timeframes that are right for you.
6. Limit your news intake
Finally, it’s important to avoid “doomscrolling,” especially when it comes to the financial press, as negative news can prompt you to make decisions based on emotions or other short-term factors. To counter any urge to invest by the headlines, take the long view. As Warren Buffett said: “The stock market is designed to transfer money from the active to the patient.”
Your financial plan: the ultimate protection from market pullbacks
Before making any investment decisions, it’s critical to match them against your goals, age and risk tolerance to ensure you’re moving in the right direction. If you need to update your financial plan, re-examine your investment strategies, fine-tune your portfolio, or simply get a fresh perspective on any investment you’re considering, contact your advisor today.
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