By Stephen P. Oliver, CFA, CFP®
The stock market can be wild—it’s down 2% one day, up 3% the next, then down again. Just when you think volatility is gone, suddenly it’s back! If you follow the markets too closely, it will drive you crazy. For example, in the fourth quarter of 2018 there was no place for an investor to hide. Interestingly, in the US stock market, as soon as 2018 ended, it experienced its best January performance since 1987. Of course, no one really knows what will happen going forward. Sticking your head in the sand does not work, nor does selling everything and waiting until the market gets better.
You cannot change the market but there are definite mistakes you can avoid and actions you can take to succeed long-term.
- Mistake #1 – Investing without a plan
The most important initial decision is to develop an investment plan that fits your investment goals and your ability to handle risk. Carefully consider how to balance what returns you need and what risk you can honestly accept. Asset allocation is the single most important decision you can make. Individual stocks, mutual funds, and ETF choices are secondary to your proper asset allocation, so choose wisely! When you have a plan that fits your investment goals and personality, stick with it regardless of market conditions.
- Mistake #2 – Not having enough cash on hand to cover your current liabilities
It’s critical to have sufficient liquidity. Selling into a falling market to raise emergency cash is like trying to catch a falling knife—good luck! The key is to have enough cash to cover up to six to twelve months. Knowing your liabilities are covered will not only help you sleep at night, but will also allow you to have a longer investment time horizon and stay disciplined in your investment plan when markets drop.
- Mistake #3 – Continuing to spend as if you were getting larger returns
Continuing to make the same withdrawals from your account as it is dropping in value accelerates the shrinkage in your portfolio. Instead, look for ways to trim your budget so you can spend less for a while. This is the other side of the coin to maintaining sufficient liquidity to cover expenses and makes your rainy day cash last even longer.
- Mistake #4 – Failing to rebalance your portfolio
No one can predict or time the market, so smart investors stay disciplined in their investment approach. Rebalancing is an important way to keep your investment plan on track, not a knee jerk reaction to a volatile market. Rebalancing is the definition of “buy low and sell high” and should be done at least once a year.
- Mistake #5 – Holding onto winners too long
Instead of holding on to high performing investments indefinitely, consider locking in the gains by selling (especially if the investment has significantly exceeded its target allocation or its initial price target). If possible, avoid short-term (less than a year) capital gains in taxable accounts since they are taxed as ordinary income.
- Mistake #6 – Ignoring tax loss harvesting opportunities
Pay attention to your after-tax return in your taxable accounts. Even in a rising market, there are normally individual holdings that lose value. Systematically selling the losers, capturing the tax loss, and replacing the security with another similar security can add substantially to your after-tax return.
- Mistake #7 – Watching CNBC all day, panicking, overreacting, and becoming impatient
This may be harder for some than others. Volatility is inherent to markets and is normal. If you have a good investment plan with a long time horizon and have proper liquidity, turn off the TV and go for a walk!
- Mistake #8 – Misunderstanding your personal risk tolerance or taking on too much risk
Bull markets make investors seem smarter than they are and cause us to ignore our personal tolerance for risk. During extreme volatility in the markets, remember to appreciate the level of risk tolerance you settled on ahead of time. Incorporating that understanding into your approach will allow you to have peace of mind about your investments and give you time to dream about other things, like what you’ll do in retirement.
- Mistake #9 – Focusing too much on individual asset returns versus your total portfolio
A well-diversified portfolio usually contains some investments that are not performing well in a given market. If you are happy with everything in your portfolio, you may not have enough diversification. A well-diversified portfolio has built-in downside protection with some assets that zig when others zag.
- Mistake #10 – Trying to time the market
Markets generally go up. When the markets are acting crazy, it’s tempting to try to avoid more losses by getting out. There are two big problems with this approach. The first is that no one is smart enough to know that the market will continue to go down. If you got out of the US stock market at the end of December 2018, which was tempting, you would have missed the best January in 30 years. The second is that it’s just as difficult to know exactly when to get back into the market!
Avoiding these 10 common mistakes will take you a long way in surviving volatile markets and meeting your investment goals. The main thing is to develop a rational, well-diversified, and balanced investment strategy and stick with it! It should fit your risk tolerance and be for the long haul. Investing is hard work—it takes effort, patience, and a disciplined commitment, but it’s the surest way to meet your financial goals.
Print version: 10 Common Investing Mistakes to Avoid in a Volatile Market