There's a lot of noise in the stock market. You have daily price fluctuations, quarterly earnings calls, speculation, and a smartphone that makes it all too easy for this to be in your face at all times. The problem with taking in so much of the stock market noise is that it can cause you to make short-term decisions that go against your best long-term interest, and that's never a good thing.
It can be costlier than you think
A common mistake people make is panicking when stock prices begin to drop during bear markets and prematurely selling their shares -- to cut their "losses" early or take a profit while they can. The thing about losses in your portfolio is they're unrealized losses, meaning they only exist on paper. If you buy a share for $100 and the price drops to $80, you've only lost $20 if you sell it. If the price increases to $120, that drop to $80 becomes irrelevant.
If you're panic-selling to hurry and lock in profits before prices drop further, the one thing you don't want to do is forget about Uncle Sam because he definitely won't forget about you. Selling stocks for a profit will trigger a tax bill. If you held the stock for less than a year, it'd be taxed at your income tax rate. If you held it for a year or more, it'd be taxed at a more favorable capital gains rate. Here are the capital gains rates for 2022:
| Capital Gains Rate | Annual Income (Single) | Annual Income (Married, Filing Jointly) | Annual Income (Married, Filing Separately) |
|---|---|---|---|
| 0% | $0 to $41,675 | $0 to $83,350 | $0 to $41,675 |
| 15% | $41,676 to $459,760 | $83,351 to $517,200 | $41,676 to $258,600 |
| 20% | $459,761 or more | $517,201 or more | $258,601 or more |
Data source: IRS.
Depending on how much you make in capital gains, you could find that the tax bill is costlier than you may realize.
For instance, imagine if you bought 100 shares of Netflix (NFLX 1.43%) in 2017 when the stock price was $170 ($17,000). In October 2021, the stock price was over $690, but it's since dropped over 65%. If you noticed prices dropping and sold your 100 shares at $500 per share, you would've made $33,000 in capital gains ($50,000-$17,000). Assuming you're in the 15% capital gains bracket, that's $4,950 owed in taxes.
NASDAQ: NFLX
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Think about the future value
A short-term decision like panic-selling can not only have present consequences (like a potential tax bill), but it can also take away from future value. Any shares you sell right now are shares you don't give a chance to grow. Let's take American Express (AMEX) (AXP 0.74%), for example. In February 2020, AMEX's stock price had reached just over $135. However, from Feb. 14, 2020, to March 20, 2020, the stock price decreased to just over $74.
Suppose someone owned 100 shares of AMEX, saw the prices rapidly declining, and decided to sell their stake at $100 per share ($10,000). Those same shares would be worth over $16,000 as of Aug. 22.
NYSE: AXP
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That's not to say that selling stocks is inherently bad, because it's not. Sometimes it truly is the best option. But, part of being a long-term investor is understanding that ups and downs in the stock market are inevitable. Once you can fully understand that, you'll begin to view down periods as opportunities to double down instead of shy away. Instead of selling your shares, you'll be looking to find great stocks at lower prices.
You can be too confident
Making questionable short-term decisions isn't reserved for down periods in the stock market or prematurely selling stocks; it can also come from overconfidence during bull markets when stock prices are rising. It's not always easy convincing someone to invest when stock prices drop because they feel they can just wait and get the same shares cheaper. However, when stock prices rise, people rush to put money into the stock market to take advantage of the gains.
"Everyone is a genius in a bull market" is the harsh truth. During bull markets, many investors steer away from conventional investment wisdom -- sometimes without even realizing it -- because even flawed businesses manage to produce good returns. It becomes more about speculation than actual investing, which rarely ends well. You don't want to buy stocks because you believe the price will produce X% returns in X years; you want to buy them because you believe in the companies and their long-term potential.
