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Three mistakes investors make in gravity-defying markets

by | Jul 28, 2021 | SELF-PUBLISHED

Wild market optimism no time to lose your common sense

  1. With the S&P/TSX Composite up 66% since the pandemic meltdown lows of last March, there’s definitely a whiff of bull in the air. Almost anything goes as the big U.S. stock indexes keep climbing to fresh record highs. The Dow Jones Industrial Average recently broke through the 35,000 threshold, an all-time record. Have stocks become weightless, overvalued, and untethered to planet Earth, following the lead of space tourism pioneers Richard Branson and Jeff Bezos? These markets have become dangerous for investors. Here are some practical tips for avoiding the three cardinal errors investors make during overheated markets.

Financial decisions aren’t always rational, and unpredictable times add to the emotionality of investors. Interest rates remain extremely low, meaning returns from fixed-income investments are limited. Meanwhile, economic growth is resuming, and inflation rates are climbing. While the Bank of Canada has started to reduce quantitative easing, interest rates are not expected to increase until at least 2023. This has contributed to the surge in equity markets.

We’ve seen in the past that periods of market volatility (in either up or down markets) are never a good time for wholesale portfolio resets, especially if you’ve built portfolios according to your true risk-tolerance levels. Still, wild market optimism can be just as unsettling for investors as deep despair during a bear market. Here are three common investing mistakes to avoid:

1. Enthusiastic buying

Acting on emotion takes people off track from achieving long-term goals. Quick reactions can yield poor financial results, and it’s important to remember that if the market is rocketing towards the moon, it doesn’t mean it’ll stay that way forever.

Avoid portfolio decisions based on rumour, hyperbole, and misinformation. Financial plans are designed to mitigate risk and recover into the next market upswing. If you get the urge to sell an asset, ask yourself why. If there is no good reason other than “the market is climbing to new highs,” re-check your risk tolerance and ability to withstand market volatility. And remember: Don’t obsess over business news. The 24/7 news cycle can add fuel to the market, making a momentum-driven market a self-fulfilling prophecy. 

The best way to keep that urge to emotional trading in check is to have an investment plan in place. It accounts for the market’s many moods and volatility, and is designed to prevent you from making moves you’ll later regret.

2. Unrealistic risk tolerance

Having an inaccurate view of your risk tolerance can lead to intemperate buying, even speculation in stocks or sectors that happen to have a good “story” and are therefore in the news. Investors must have a true fix on how much of their portfolio value they’re comfortable losing if there’s a sudden drop in the stock or in the market. I happens all the time. It’s not a pretend game.

Investors often say: “I can live with the risk, and besides, the market keeps moving up.” But you need to ask, can you really? This was put to the test with the advent of the Covid-19 pandemic and the sudden stock market crash in March 2020. 

When determining your true risk tolerance, put it in specific dollar terms. Take the full value of your portfolio across all accounts and apply to it the percentage drop you think you can withstand. How many dollars is it? Can you live with the loss?

3. The futuretrap

No one has a crystal ball, and attempting to time the market is a version of crystal-ball gasing. To buy and sell successfully at market tops and bottoms is almost impossible to achieve consistently. Stick to a disciplined strategy and don’t become victim to the herd mentality.

By trying to time the market, you’ll likely incur trading costs and be no further ahead. Good investing is about planning. Choose how much money you want to allocate to each of safety, income, and growth assets within your portfolio. And then stick to the allocation.

Novice investors often fall victim to the “wishful thinking” syndrome. They will buy an investment because it has recently gone up in price, in the expectation it will go up some more. Remember the phrase “past performance does not guarantee future results.”

Don’t follow the herd. Investors often stampede into or out of individual investments, sectors, asset classes, and entire markets at the same time. Really, the market is nothing more than the combined actions of millions of investors. Doing what “the market” is doing could mean disaster if it suddenly goes over a cliff.

Stick with the plan

Stick to your financial plan and trust it. Don’t succumb to market enthusiasms. Remember the old adage, “In a bull market, everyone’s a genius.” But bull markets don’t last forever and often come to a bad, and unpredictable end. Seek the proper financial advice such as help from a Certified Financial Planner.

© 2021 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

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