The Australian share market is down around 7 per cent from its recent highs amid investor concerns around inflation, potential interest rates hikes and the conflict in Europe.
A dip of this size isn’t uncommon; in fact nearly every year there’s a similar fall in the market at some point.
As the table below illustrates, the average intra-year market fall (represented by the blue dots) of the S&P 500 has been 14.2 per cent between 1980 and 2015. Yet annual returns over that period (represented by the grey bars) were positive 27 of 36 years (75 per cent ). This means that markets generally end the year higher despite dips along the way.
Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Intra-year declines refers to the largest market drops from a peak to trough during the year. For illustrative purposes only. *Returns shown are calendar year returns from 1980 to 2015. Data as of 31 December 2015.
Here are the six mistakes to avoid so you can stay on the road to investing success.
Mistake #1: Selling your portfolio
Many investors make the mistake of selling when the market falls. Their fear is that any rebound will take years.
This thought process is completely understandable. Research shows people feel the pain of loss twice as much as the enjoyment of profits, and will often react without thinking. It’s our fight-or-flight response, it’s our amygdala (the part of our brain that regulates emotions) in overdrive trying to prevent loss.
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However, a gut reaction is likely to negatively affect your returns. Market movements and losses have always been followed by longer periods of gains and recovery. But, if you exit the market in a panic, you risk not being invested when the market rebounds, and it might be too difficult to buy back in at a higher price.
Stay calm and remember that time in the market, instead of timing the market, is the secret sauce of long-term investing. We recommend all clients have at least a three-year investment time frame, because the longer you invest and ignore short-term price moves, the better your chances of making a great return.
Mistake #2: Changing your portfolio strategy
Changing your portfolio risk in reaction to market performance is a form of market timing and similar to selling your portfolio. Unfortunately, the result is the sale of investments that have fallen the most in price.
There are certain circumstances where it’s appropriate to change your investment strategy. But selling investments at a low point is generally not the way to go.
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If you have a tendency to get nervous when your investments go up and down, consider monitoring your portfolios less frequently. This helps prevent your short-term emotions from overpowering the long-term game plan.
Mistake #3: Not topping up your investments (if you have the means)
Market dips can be a good time to top up your investments since you’re able to benefit from buying shares at a cheaper price. Think of it as a 10 per cent off Black Friday sale at your favourite store. Hardly something to run from!
If you set up regular deposits to your investment account, you can manage the risk of market dips and balance out how much you pay for your investments through dollar cost averaging.
Mistake #4: Not reinvesting your dividends
Even though the value of shares might decline over the short term, many companies will still be paying dividends. When markets fall, dividends and distributions can be reinvested at a lower price, helping you benefit even more when share prices go up again.
Mistake #5: Not rebalancing your portfolio
Rebalancing is another way to take advantage of market dips.
Portfolio rebalancing is the process of realigning the assets in a portfolio to desired levels. It involves periodically buying or selling assets in a portfolio and can be difficult to do on your own.
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As an example, Stockspot automatically rebalances clients’ portfolios. In March 2020, at the start of the pandemic, Stockspot sold gold and bonds, which had performed well, and invested the profits into share markets that had collapsed.
Mistake #6: Not diversifying your investments
Whether the market goes up or down – and for how long – is unknown. You’ll cause yourself unnecessary stress if you try to predict anything, except uncertainty itself.
What is within your control is avoiding the mistakes above, as well as building a portfolio that can weather uncertainty. If you have a properly diversified portfolio (investments in several asset classes), you can ignore market dips.
Research has shown that setting yourself up with a sound investment strategy and ignoring the movements of the market leads to much better outcomes than trying to outsmart the market.
In short, if you’ve focused on setting yourself up with a diversified portfolio that’s rebalanced appropriately, simply stick to your strategy, stay invested, and perhaps top up if you have the cash reserves.
Adopting this mindset will stop you veering off the road to investing success.
Chris Brycki is the founder and CEO of Stockspot, an online investment adviser founded in 2013. He has had more than 25 years of investment experience and spent most of his early career as a portfolio manager at UBS.
Are you guilty of making any of those mistakes? What lessons have you learnt over the past two years? Why not share your views in the comments section below?
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