We have all heard the phrase “buy low and sell high.” However, that simple advice is not so simple to put into action when the bad news starts rolling in. Often, average investors succumb to panic and sell low in times of gloomy market conditions. Letting emotions drive your investment decisions can lead to the loss of enormous sums of money over your entire lifetime. Holding your investments through even the most dreadful times will give you the best chance of accruing the most money for your financial goals.
Emotions are part of what makes us human. They inspire amazing works of art and help us make deep personal connections. As you are probably aware, emotions can also get us into a ton of trouble. This is especially true when it comes to investing. What separates good investors from poor (literally and figuratively) investors is being able to push emotions aside and think critically about the world.
In a 2014 study, Morningstar calculated that investors lose 2.5% a year by mistiming the market. Below is a chart that shows the average 10-year returns for several types of funds and the average 10-year returns for investors in those funds. If the investors simply bought and held, those returns would be the same. Unfortunately for them, they tried to time the market.
An overreaction to bad news can be extremely costly. Two and a half percent may not seem like a lot, but it adds up in a big way over extended periods of time. For example, let’s say you are saving for retirement by contributing $1,000 a month to your retirement account. Let’s also assume that you have 35 years left until retirement. A well-diversified portfolio may earn you 7.5% a year if you buy and hold (with a rebalancing strategy). On the other hand, you would only earn 5% a year if you let your emotions get the best of you. If you were to invest without emotion, you would end up with about $2 million at retirement. If you were to succumb to emotion, you would end up with only $1.1 million. Letting emotions dictate your investment decisions could literally leave you with half the amount of retirement savings.
Most of the time when you hear bad news about markets, the selloff will be very temporary. On rare occasions, small selloffs can turn into a full-blown economic crash. Below is a chart of the past 100+ years of the Dow Jones Industrial Average. Eighteen recessions are marked with gray lines. That means a recession occurs about every 6 years on average. These are usually the periods where investments are most at risk. Of course, markets can also crash without a recession. The severe crash of 1987 is a perfect example of a market crashing without a recession.
Take close notice of how the stock market’s trend is overwhelmingly upward. We may have sharp selloffs for a year or two in a row, but they are rare and have always turned around. If you are to take any action during market turmoil, think about buying even more assets. Remember, the goal is to buy low and sell high. Market crashes are the best times to find exceptionally low prices.
Even in times of recession or a major market crash, you should suppress your negative emotions and sit tight. If the situation is truly getting ugly, you should talk with a financial professional before making any major changes to your portfolio. However, you should never act in haste and sell all your assets when the market is tanking. The only time it may be necessary to sell during a market selloff is when you are less than five years away from retirement.
First, put together a well-diversified portfolio made up of stocks, bonds, commodities, cash and other assets. A wonderful way to achieve diversification is by investing in Exchange-Traded Funds (ETFs). Next, continually invest in your portfolio with as much money as you can possibly spare each month. Finally, ride the market waves, no matter how bad the news gets. You will also find it useful to rebalance your portfolio to maintain the proper risk exposure. These are the simple rules to follow to ensure yourself a lavish retirement.