Why do so many of us do it?
Perhaps it’s because our brains are hardwired, telling us to run when we sense danger. Whatever the reason, when the stock market goes into a serious correction and prices fall, many investors tend to panic. Their brains seem to send them an urgent message declaring it’s time to sell.
Conversely, when things are humming on Wall Street and prices are hovering at their highs, those same investors can’t wait to get in on the action. The result for those investors (some experts say most investors) is the costly mistake of selling low and buying high. That, of course, is the precise opposite of the path followed by the most successful investors, who buy low and sell high.
While it’s true that pulling out of a bear market when prices are dropping can appear to benefit your investment portfolio by limiting short-term damage, it can also cause you to miss out on the inevitable rebound that follows a big drop by failing to get back in the market soon enough.
Being out of the market, even for a short time, can result in the loss of considerable wealth-building profits. So what should you do during a market correction? Many financial professionals recommend holding tight and doing nothing.
“Often, the wisest thing to do during periods of extreme market volatility is to stick with the investment plan that you’ve already devised,” says Bill McNabb, Vanguard Fund’s chairman and chief executive officer. “Equity markets have reaped sizable gains over the past six years. Such setbacks, while unnerving, are inevitable.”
Such a do-nothing approach might be a tough path to follow when you’re frightened by sharp, unrealized losses in your investment portfolio, but turning those unrealized losses into real ones by selling out can often be the worst thing to do. McNabb points out that no action is actually an active decision, and can be the right decision for reaching your long-term financial goals.
And McNabb is not alone in his feelings. “When the markets are rising strongly, investors are more likely to put money into stocks (buying high),” says Charles Rotblut, a certified financial analyst. “When a steep market correction or a bear market occurs, many investors move to sell their stocks (selling low). Then, once the market has rebounded and recorded significant gains, those same investors notice the profits they are missing out on and they decide that it’s time to put money back into stocks. This repetitive cycle results in a process of locking in big losses and missing out on big gains.”
While most financial professionals recommend that you sit tight during major market corrections, there are those, including Warren Buffet—often cited as the world’s most successful stock market investor—who say that such a time is a rare opportunity to build your wealth by buying stocks.
Not every investor will have the stomach to buy more stocks when prices are falling, even though history tells us that Buffet is correct in his belief. For those of us who find that even a do-nothing approach can be unnerving when stocks are taking a nose dive, here are some things you can do to help settle your nerves:
Remind yourself that stock corrections are common and inevitable
The history of equity investing is peppered with major and minor corrections. In the past 100 years, starting with the “Black Tuesday” market crash of 1929, to the real estate bubble crash of 2008, to the recent Chinese economy correction starting in June 2015, there have been more than a dozen significant market corrections. Every one of those was followed by rebounds that led to new market highs (except for the most recent that hasn’t had time yet to follow suit).
Clearly, history is on the side of those who say stick to your own investment plan by sitting tight during a stock correction. Of course, it’s important that you have a plan of your own, including a well-diversified portfolio in order to benefit fully.
Don’t let emotion get the best of you
Constant checking of stock prices during a market decline coupled with exposure to doomsayers’ market predictions is sure to rattle you more than it should. When emotions dominate your decision-making process, good judgment often suffers.
Successful investors have learned to make a special effort to prevent emotions from unduly influencing investment decisions, particularly sell decisions. Perhaps the best way to accomplish this is to break the habit of agonizing over daily fluctuations in market prices.
Make market volatility work for you
Once you come to terms with the fact that market volatility and periodic market corrections are inevitable and normal, it’s time to put that knowledge to work for you instead of letting it wreck your portfolio.
Continue to invest on a regular and planned basis regardless of fluctuations in market prices. In order to put market volatility to work for you, it’s important to participate in an automatic investment plan such as an IRA or 401(k), a target date mutual fund, or some variation of your own plan for regular investing. Remember: The more you invest when market prices are down, the more you will benefit when prices rebound.
While there is no guaranteed formula for optimum success in managing your investment portfolio during market downturns, the evidence strongly suggests that the best plan of action for most investors is a plan of inaction.
William J. Lynott is a freelance writer whose work appears regularly in leading trade publications and newspapers as well as consumer magazines including Reader’s Digest and Family Circle. he can be reached at email@example.com or through blynott.com.