Stock markets saw a rapid decline towards the end of February 2020. Stoked by fears over the spreading coronavirus and its potential impact on businesses, the market suffered. Investors were dumping stocks and fleeing to safe havens such as bonds and gold. The S&P 500 Index saw a 20% decline in the first quarter of 2020 that officially signals a bear correction. Many stocks have fallen more than 20%.
Despite the turmoil, there are a number of steps you can take to protect yourself from financial losses when markets dip. Perhaps more importantly, there are costly mistakes that you need to avoid. Here are five blunders that every investor should be aware of. Don’t do these things when markets are down.
Not Using Stop-Loss Orders
Stop-loss orders are an important tool in every investor’s tool chest. Stop-loss orders can be used to both limit losses or secure profits when markets prices fall sharply. Here’s how a stop-loss order works. Say you buy stock XYZ at $250 per share. Over time, it rises to $350 a share. You then put in a stop-loss order to sell your position in the stock if it falls to $300 a share.
Then the market plunges. So does the price per share of company XYZ, dropping down to $260 a share. However, with your stop-loss order in place, you automatically sold all your shares once the stock price hit $300. By selling at $300 a share, you limited your potential losses and still realized some of your gains. You’re now sitting on cash and profits from your stake in company XYZ.
Stop-loss orders also provide peace of mind, so you don’t feel the need to constantly check how your portfolio is performing. Essentially, stop-loss orders are supposed to put a floor underneath your stock holdings. However, there are rare occasions when the number of sellers are so great that a stop can be overrun. In other words, using them will reduce the risk of your investments from free falling if the market takes a sudden and steep downturn — but they are not a guarantee.
Buying Back Into The Market Too Soon
“Have we hit bottom yet?”
That’s the question on every professional trader’s mind when markets plummet. It’s a question that should be on the minds of individual investors too. A lot of DIY investors lack patience in a down market. They buy stocks too quickly, only to see the price fall further.
Maybe you look around and see potential bargain prices on stocks you’ve always wanted to own. For example, what if a stock was at nearly $920 a share a week ago, but is now trading under $780 per share. Does that mean now is a good time to buy? Or will the company’s stock price be under $500 a share in another week or two?
The simple truth is that nobody knows. It will take time for the market to hit bottom and begin rising again. Buying stocks too soon after a drop, only to watch the price per share slide even further, can be a frustrating and costly experience. After all, buying high and selling low is always a recipe for disaster. Better to sit on the sidelines, be patient, and wait to see just how far the market will fall before it regains its footing. In a down market, patience really is a virtue.
Forgetting That Cash Is King
Many people feel that once they sell their stocks or equities, they need to rush and put that money into bonds or gold reserves. They seek some type of investment that’s safe and stable. But what is wrong with holding onto the cash you just made?
For some reason, there is an irrational fear of holding cash. The belief is that having cash on hand means that you won’t be seeing any growth or earning any interest. But cash is still king, especially in a down market. Holding onto cash means your money is safe. Sure, it can’t gain. But it also can’t lose. (Well, technically it can lose value to inflation over a long enough period of time). It also means you can act quickly when markets pick back up. Use that cash to buy back into stocks once markets finally bottom out and share prices being rising steadily again.
Consider that Warren Buffett, the most successful investor of all time, is currently sitting on a cash pile of more than $100 billion. Buffett has infinite patience. He will not put any of his money into an investment unless he thinks it’s a good deal and fair price. In fact, when stocks were at record highs a few weeks ago, Buffett said that there were many companies he’d like to buy into but he felt their share prices were too high. Rather than invest, he said he would continue to sit on his cash pile and look for bargains. This is a lesson all investors should heed.
Making Too Many Trades
Constant trading is costly for investors. Many brokerages earn money on the commissions they charge for making trades. Buying or selling one single share of a company can cost as much as $5 or more. Buying or selling thousands of shares can cost hundreds of dollars. You would think that these commission fees would cause investors to think strategically about the trades they make. However, logic often seems to go out the window when stock markets are plunging around the world.
Many investors make dozens of trades at a time – selling partial positions in some stocks, dumping entire positions in others, and buying into stocks when they think they see bargains. The result is hundreds, sometimes thousands of dollars, on brokerage commissions from all their trading. Any profits realized have probably been eaten up by commissions and fees.
This is a mistake and one that investors often come to regret. Containing your emotions, being aware of the commissions and fees charged by the brokerage you use, and making strategic trade decisions is the best approach.
Forgetting Your Time Horizon
Bear markets come and go. Stock market corrections occur and crashes happen. Historically, the S&P 500 Index, which tracks the 500 largest companies in the U.S. by market capitalization, has a down year 25% of the time and an up year 75% of the time. You can’t expect that you’ll be in a bull market all the time.
The important thing to remember is your investing time horizon. If you’re investing for retirement, is your time horizon five years, 10 years, 15 years, or longer? The longer your time horizon, the less you should worry about the ups and downs of global stock markets. They have time to recover from any downswings.
Turning to Buffett again, he often says investors should do nothing when the stock market plunges. Instead, he advises you to buy stocks in companies you understand and trust. Purchases your shares at a fair price, and then forget about them. Buffett famously said, “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.” He also said, “Our favourite holding period is forever.”
The point is that you shouldn’t feel obligated to do anything when markets take a downturn. You can simply hold onto your investments and wait for markets to rebound. Over a long enough time frame, the market has always rebounded and come back stronger. So unless you’re planning to retire in six months — in which case your investments should already be in more stable vehicles — don’t panic.