This year the share market will probably fall 10% at some point.
This statement isn’t a grand prediction about the state of the economy. Nor is it about the value of shares. It’s simply an observation based on every other year: markets never move in a straight line and nearly every year there’s a 10% fall (or more) 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% between 1980 and 2015. Yet annual returns over that period (represented by the grey bars) were positive 27 of 36 years (75%).
When the market next has a 10% dip (or any dip at all), remember a rise is somewhere round the corner. In the meantime, 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 than the enjoyment of profits, and will often react without thinking. It’s our fight-or-flight response: it’s our amygdala in overdrive trying to prevent loss.
However, a gut reaction is likely to have a negative effect on 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 rather – not 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.
For example, changing from a Stockspot Topaz portfolio (a high growth strategy) to a Stockspot Amethyst portfolio (a conservative strategy) would result in selling Australian shares and buying Australian bonds. Doing this after a 10% market fall would harm your returns since you would be selling shares relatively low and buying bonds relatively high.
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% off 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.
For example the Vanguard Australian Shares ETF (VAS) and iShares Core Composite Bond ETF (IAF) will both pay distributions in July 2021 which we’ll try to re-invest or rebalance client portfolios to keep them on track.
Mistake #5: Not rebalancing your portfolio
Rebalancing is another way to take advantage of market dips.
Portfolio rebalancing is the process of re-aligning 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 shares markets that had collapsed. The share market rebounded, and as a result, many of our clients are up 35% or more on the extra shares we bought for them.
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.
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 help 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 yourself 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 focussed 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.