The ASX has been going through some turbulence of late with market corrections in America and Asia giving Australian shares a bit of a cold.
Our market dropped 6% in a single day in early August 2024. It’s important to remember that market dips aren’t actually uncommon. In fact, there’s a 10-20% fall in the market nearly every year.
Despite regular market dips and economic recessions, Australian shares have still earned investors on average 10.9% p.a. since 1926, so it pays to stay invested and be patient when markets have periods of negative returns.
Many investors make the mistake of selling when the market falls, concerned that the economy is heading towards a recession. Their fear is that the economy may get worse and any rebound will take years.
At this period in 2024, that is elevated by fears from the US that they are about to go into a recession, which could be passed on to Australia.
This thought process is completely understandable. Research shows people feel the pain of loss twice as much than the enjoyment of profits.
They will often react without thinking. It’s our fight-or-flight response. Our amygdala (the part of our brain that regulates emotions) is in overdrive trying to prevent loss.
However, a knee-jerk reaction is likely to negatively affect your returns, so it’s important to avoid panic.
With that in mind, here are six mistakes to avoid when markets fall so you can stay on the road to investing success.
Mistake #1: Selling your portfolio in fear of a recession
Market movements and losses have always been followed by longer periods of gains and recovery.
If you exit the market in a panic, however, you risk not being invested when the market rebounds – by which point, it might be too difficult to buy back in at a higher price.
There have been 12 recessions in the US since World War II – the share market has risen during half of them.
The share market is often ahead of the economy, so by the time any recession hits, the market might already be on the way back up.
Stay calm and remember that time in the market, instead of timing the market, is the secret sauce of long-term investing.
We recommend clients have at least a three-year investment timeframe, because the longer you invest, 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.
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 Black Friday 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.
Stockspot automatically rebalances our clients’ portfolios.
In March 2020, we sold gold and bonds which had performed well and invested the profits into share markets that had collapsed. The share market rebounded, and as a result, many of our clients were up 40% or more on the extra shares we bought for them when we rebalanced again in November 2020.
Mistake #6: Not diversifying your investments
While the broad share market index is down, there are sectors that have fared much worse during this market dip.
US stocks lost 8% in a week while Japanese stocks lost 20%, including 12% in a single day.
If you have a properly diversified portfolio (investments in several asset classes), you can ignore market dips and not worry about catastrophic losses that can occur when you have invested into a single asset or sector.
Index investing comes out stronger from each market crisis because loss-making active investors and day traders convert to a diversified indexed approach.
At Stockspot, we prepare for uncertainty and dips in the market by investing across a broad range of different investments.
Defensive assets like bonds and gold are a proven way to protect a portfolio and provide a cushion when markets dip.
If you diversify, you’ll avoid large losses from a single investment. This can make a big difference to your sanity when markets fall.
Research has shown that setting a diversified 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.
