One of the biggest mistakes do-it-yourself investors make is to sell investments at precisely the wrong time. Mostly, this is because smaller investors who “play the market” tend to be “reactive” rather than “proactive.” And mostly, they react to the two primal investor emotions – fear and greed.
The fear factor
January’s stock market selloff was a prime example of fear driving investor decisions. Emerging markets faced an exodus of capital and consequent exchange-rate weakness as investors grew anxious about their growth prospects. For a while, the selloff in emerging markets also infected developed-nation stock markets as investors got into the “risk off” mode and switched into “safer” assets like U.S. Treasury bonds.
But the U.S. continued to show underlying strength in job creation, manufacturing, and a declining unemployment rate, along with estimate-beating fourth-quarter financials from most S&P 500 companies. The U.S. Federal Reserve Board, now led by new chairman Janet Yellen, stayed the course on tapering its bond purchase program, suggesting the Fed doesn’t really see any storm clouds gathering on the horizon. Institutional and hedge fund money flooded back into North American stocks, resulting in the recent powerful rally.
Those investors who sold out of the market at the end of January on fears that a real “correction” was underway (when the market declines by 10%) were subject to a classic whipsaw. They broke up with the market just before it turned around and spruced itself up again.
It works the other way, too. Smaller investors will sit around just about forever watching a bull market unfold…and then decide to invest right at the top, just before a major decline! That’s the greed factor kicking in.
How to avoid being whipsawed by the market
So how do you avoid getting whipsawed by the market? Here are a few tips:
1. Don’t sell (or buy) on emotion. And let’s be frank, here. The market is an emotional place. There’s fear. There’s greed. There’s high drama. You can grow too attached to an investment. Or come to loathe it for no good reason. Or you can be a lemming, and just do what everyone else does, happily running over a cliff.
If you get the urge to sell an asset, ask yourself why. What is it about the asset that’s changed? Have a stock’s fundamentals deteriorated badly – revenue, cash flow, earnings? Has the company declared bankruptcy? What’s changed since yesterday, when you thought your investment was brilliant? Has the stock reached your pre-determined sell target level? If you have no good reason other than “the market is falling,” you’d better re-check your risk tolerance and your ability to withstand market volatility.
2. Have a plan…and stick to it. The best way to keep that urge to emotional trading in check is to have an investment plan in place. Decide what your goals are, and allocate your assets according to a realistic assessment of your investment temperament – before you jump into the market. As the writer George Goodman (“Adam Smith”) once put it, “If you don’t know who you are, this is an expensive place to find out.” Many (perhaps most) investors overestimate their ability to tolerate risk and market volatility.
Your investment plan will take into account the market’s many moods and its volatility. Your portfolio will be built to be more “defensive” or more “aggressive” to suit your needs, with built-in risk-mitigation derived from proper asset diversification. That means you shouldn’t have to worry about the market’s ups and downs – your portfolio should perform comfortably within the parameters you’ve set, with no need for you to go and meddle and “try to make it better.”
3. Get the right advice. This might seem self evident, but even my new high net worth clients who seek my counsel complain that they just weren’t getting the right kind of financial advice. And that’s absolutely true if you base investment decisions on the latest business news headlines. That’s just a variant of trading on emotion, and something to avoid at any cost. Almost as bad is the type of “advice” that comes from relatives, neighbors, colleagues, or unsolicited pitches for this or that “unbelievably good investment opportunity.” The only unbelievable part is that anyone would fall for this.
Shop around for a qualified independent investment advisor or Certified Financial Planner, preferably one who isn’t tied to a specific company’s product lines. They’ll be able to give you an honest appraisal of your current investment situation, recommend a plan, suggest an appropriate portfolio mix, and keep things on track with regular communication.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.
