Following a bull market from mid-2020 through the end of 2021, the stock market has had a humbling 2022, with many great companies and major indexes dropping well into the double-digit percentage range. It's easy to get your emotions involved whenever you're dealing with money, especially when you're seeing your portfolio's value dwindle daily. During bear markets and downturns in the market, investors may begin panicking and selling investments to avoid the value dropping even further, but this is the wrong approach to take.
One of the best lessons investors can learn is that down periods are as much a part of the stock market as stocks themselves. If you're focusing on the long term, however, short-term price movements shouldn't discourage you or make you lose sight of your financial goals.
Taxes could add insult to injury
Nobody likes losing money -- that defeats the purpose of investing. However, it's important to understand that losses in your portfolio are unrealized. These unrealized losses don't become permanent losses until you decide to sell your shares. If you believe in the long-term potential of your investments, though, there's no need to sell them and lose money because you panicked watching prices drop.
Even if you panic-sell your stocks for a profit, you could end up adding insult to injury when you account for the potential tax bill. Imagine if you bought 100 shares of Etsy back in 2017 at $15 each and decided now to sell those shares for $80 after witnessing the stock price plunge close to 60% year to date. Even though you would have made $6,500 in profits, you'd also owe capital-gains taxes on that amount. At a 15% capital gains tax rate -- which many people will pay -- that's a $975 tax hit.
If it was a situation where you owned the stock for a year or less, the tax hit could be even greater because you'd pay your regular income tax rate on profits instead of the more favorable capital-gains rate.
Think of the opportunity cost
Not only should you think about the present consequences of panic selling your stocks, but you should also consider the potential missed opportunities in the future. Although your investments may not perform well in a bear market, that doesn't mean they won't rebound and produce great long-term returns.
Will all companies make it through rough economic periods? Unfortunately, no. But history has shown that blue chip companies and major indexes tend to rebound at some point. You don't want to find yourself selling your investments and then watching those same shares later surge right before your eyes, potentially costing you more to repurchase them.
From January 2015 to October 2015, Walmart's stock dropped by more than 35%. Had someone sold their shares during that time, they would have missed out on the 120% share-price gain that Walmart has generated since then -- even though the retailer's stock is down 13% year to date. And that's just the increase in stock price -- it doesn't account for the dividend payouts missed during that time.
Panic-selling your shares can not only cause present-day losses, but it can also cause you to miss out on future profits. If you're buying a stock, it should be because you're planning to hold it long term. Don't lose sight of that and make short-term decisions that go against your best long-term interest.