For many investors, it feels like the stock market is crumbling. When you look at the major indexes, all trade within 5% of their all-time highs as of this writing, so this isn't a stock market correction or bear market yet. But unlike the index averages, many popular stocks are sharply down. For example, two of the largest holdings in my personal portfolio, Pinterest and Magnite, are down 35% and 60%, respectively, from highs set earlier this year. That hurts.
Many investors, therefore, are experiencing a market downturn. And events like this are taxing on an investor's psychology. If your portfolio has already taken a big step backward, here are three things you'll want to avoid doing right now.
1. Try to fix your portfolio quickly
I've already mentioned that two of my favorite stocks are dropping and it's painful. But this isn't a metaphor, it's science. The Wellcome Centre for Human Neuroimaging at University College London did a study of brain activity among gamblers when they lost money. As reported by ScienceDaily, MRIs showed that losing money triggered fear and pain sensors in the brain.
Humans have a hardwired response mechanism to pain and fear: Run! And that's a problem when it comes to investing. Our first reaction is to sell the stocks that are down the most and rid ourselves of this unenjoyable experience.
Of course, we investors don't talk about it this way. Often, we choose to sound much more stoic and intelligent by selling "low conviction" holdings and redirecting money to stocks with better growth and more upside. But if we're honest with ourselves, we're really just trying to do what we can to fix this problem right now.
There's nothing wrong with selling a stock. And there's nothing wrong with buying a new stock when your conviction is strong. But if you're making moves simply because your portfolio is down, you'd better reexamine that decision to ensure you're not just running from pain and fear.
2. Wait on the sidelines
When stocks go up, optimism takes over and we see only blue skies ahead. When they fall, pessimism sets in and clouds our long-term vision. As an illustration, consider what professional stock analysts have been doing with their price targets in recent weeks. In the first two months of 2021, analysts were raising their price targets for stocks left and right. Just weeks later, price targets are being revised downward -- coincidentally after the pullback started. It's clear: Analysts are simply reacting to current market conditions.
Reactionary investors are likely waiting on the sidelines right now, unwilling to buy stocks for fear they could fall further. And indeed they could. But no one can predict the bottom. And missing out on even just a few days of recovery can wreck long-term returns.
Fidelity did a study of the stock market from January 1980 through August 2020. If you missed just the 50 best days of returns over this 40-year span, your portfolio would be worth 93% less than if you'd been invested the entire time. Therefore, waiting on the sidelines for stocks to fall further before investing isn't the way to go -- you can't risk missing just a few great days of returns. And it's why some would suggest investing in every bear market.
3. Throw away your shot
In 1988, legendary investor Warren Buffett said, "If you want to shoot rare, fast-moving elephants, you should always carry a loaded gun." His point was that sometimes the market gives you a life-changing investment opportunity. And when it does, you need to be prepared to seize the opportunity by investing a large amount of money fast. But while this Buffett quote is chock-full of investing wisdom, it's probably the wrong move to go all-in on any stock right now.
Life-changing opportunities that require swift, decisive capital-allocation moves are "rare" -- this part of the quote is often discarded by investors who wish to emulate Buffett's success. By definition, most stocks don't fit this criteria right now.
So don't wait on the sidelines but don't shoot your shot, either. Both are overreactions triggered by our desire to mitigate pain and fear. Is there a stock you like that's trading well below its high? Consider buying some as part of a methodical, long-term investing strategy. Don't treat it as a once-in-a-lifetime buying opportunity. Most of the time, it isn't.
These are three things not to do. In light of these, here's the takeaway for investors: Develop a long-term investor mentality, consistently adding to stocks in great companies and holding for years. There will be short-term downturns, as there are right now. But by remaining disciplined and focused, you can continue to benefit from a stock market that goes up most of the time.