Investing is just as much about learning from mistakes as it is about choosing quality companies and holding them over time.
No one knows if 2023 will end up being a better year in the stock market than 2022. And when the next bull market does come, it's equally difficult to determine which stocks or sectors will lead that rally.
Instead of speculating on the short term, a more fruitful endeavor could be to focus on avoiding mistakes during a prolonged bear market. Here are three mistakes that could prove disastrous during any market cycle, but especially during a bear market.
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Letting uncertainty override your analysis
Day after day of declining asset values takes its toll on any investor. Bear markets have a way of bringing out our greatest fears and doubts in even our most confident investment theses. When a stock is falling with no end in sight, it's understandable to second-guess whether you missed something. Sometimes, the answer is yes. But if your research is sound, then maybe an investment thesis just needs time to play out.
Too much fear and doubt will prevent a person from doing just about anything. Worry too much about an accident, and you'll never drive a car or ride in an airplane. Worry too much about everything that could go wrong with a stock, and you could end up discounting what could go right.
Staying even-keeled about your investment, regardless of the market cycle, is a good way to digest the pros and cons without talking yourself out of a sound investment or investing too much in a single idea.
Putting yourself in uncomfortable situations
Making a calculated decision and incurring a loss is painful. But it's a far worse feeling to accidentally become overly invested in a company you don't fully understand or believe in -- or simply realize that your portfolio is misaligned with your risk tolerance.
When stock prices are tumbling, it's hard to feel comfortable to begin with. But if your investment portfolio is aligned with your objectives and risk tolerance, you'll stand a far better chance of outlasting a prolonged period of volatility.
Investing is just as much a psychological battle as it is a strategic one. Alleviating pressure on your portfolio by focusing on your best and highest-conviction ideas will make losses easier to stomach by allowing you to take ownership of your decisions, instead of feeling helpless or confused.
Altering your approach to try to beat the market
Every year, there will be different sectors, stocks, exchange-traded funds (ETFs), and intuitional investors that are praised for beating the market with a unique strategy. In 2020, oil and gas stocks crashed while renewable energy stocks, technology, consumer discretionary, and communications stocks did very well. Cathie Wood's Ark ETFs were soaring, while Warren Buffett's Berkshire Hathaway (BRK.A 0.01%) (BRK.B -0.02%) underperformed the S&P 500's total return by 16 percentage points in 2020.
But in 2021 and 2022, energy was the best-performing sector. The strength of value stocks relative to growth stocks helped the Dow Jones Industrial Average outperform the Nasdaq Composite by the widest margin since 2000. And Berkshire Hathaway stock ended positive on the year, whereas the S&P 500 fell around 20% and the Nasdaq Composite fell over 33%.
Jumping in and out of whatever is working at the moment is a great way to let uncertainty override your analysis, while also putting yourself in an uncomfortable situation by owning companies you don't believe in long-term. However, that doesn't mean that you can't learn from the gyrations in the stock market and use that information to better align your risk tolerance with your investments.
For example, the rapid value expansion and then contraction of many hyper growth stocks could be too volatile for investors with a low risk tolerance. In the same vein, stodgy low-growth companies may be a place of refuge for folks during a bear market. But even as these stocks are performing well, they may be too conservative for investors with a longer time horizon or those with a higher risk tolerance.
Empower your financial health in 2023
By understanding that different assets will outperform the market during different times (in often unpredictable ways), an investor can realize that trying to predict what will happen over the short term isn't worth it. Rather, the better approach is to find companies that you like, and that can deliver on their investment objectives over a long period of time. Sometimes, the goal is to compound growth faster than the market. Other times, the goal isn't to beat the market, but rather, to find a safe stock at a good price with a growing dividend that can supplement income in retirement.
There's no need to hide under a rock during a bear market and wait for it to be over. Rather, you can filter out the noise and stay informed without letting the day-to-day price action drastically alter your investment strategy.
