2022 was a brutal year in the stock market, and the performance of the broader indexes doesn't come close to telling the whole story.
Even well-known Wall Street darlings and some of the largest companies by market cap saw the biggest drawdowns in their stock prices in over a decade. Meanwhile, many smaller growth stocks lost 90% or more of their value.
In addition to the stock price action, there was a slew of dramatic news items related to cryptocurrency, geopolitical tensions, the housing market, and the macroeconomic environment. Needless to say, the coupling of falling asset values and scary headlines is a recipe for uneasiness in 2023.
The turn of a calendar year is the perfect time to conduct a portfolio checkup, as well as reevaluate your investment objectives. But it's also a time when it's easy to overthink and try and make back losses too quickly.
There are several mistakes investors can make in 2023 -- the usual suspects include investing in companies you don't understand, investing money you can't afford to lose, and investing based on a short-term timeline. But I would argue the biggest mistake that investors can make in 2023 when it comes to their stock portfolio is to play the wrong game. Here's what that looks like and how to avoid it.
Image source: Getty Images.
Understanding the playing field
In his book The Psychology of Money, Morgan Housel has an excellent chapter on the pitfalls of (often accidentally) playing the wrong game in the stock market. And he describes the stock market as one field on which several different games are being played.
You have investors with varying amounts of money and different time horizons who may be directly or indirectly betting for or against a given stock or the market as a whole. All of those inputs are going to cause a stock's price to stray from its long-term intrinsic value. Or in other words, that activity causes stocks to become overvalued or undervalued all the time.
The vast majority of retail investors who are regularly adding savings to stock portfolios that they have no intention of withdrawing from anytime soon are better off focusing on the information that is relevant to the game they are playing. In a nutshell, that means defining a company's investment thesis and making sure the company is on track to deliver on that investment thesis over time.
A lot of the noise that stock prices react to on a day-to-day basis has next to nothing to do with a long-term investment thesis. That being said, it's essential to be aware of the games that other players are engaged in so you know why a stock can move the way it does.
What the impact of different games looks like
Let's take a real-world and easy-to-understand example of the dangers of getting caught up in the wrong game using Walt Disney (DIS -0.55%) stock.
Disney stock is hovering around an eight-year low less than two years after reaching an all-time high of over $200 per share on March 8, 2021. The more than 55% decline from that all-time high in such a short period of time can be mind-numbing for investors, especially given the established and dominant market position Disney has around the world. But the stock price fluctuation is merely a result of the effects that perception can have on a business.
Disney+ launched in Nov. 2019. And despite a slowdown in Disney's parks and movie business during the pandemic, the stock price held up, because interest rates were low and investors were thinking about the future value of Disney with the addition of its streaming service paired with a full reopening of its other core businesses.
But Disney stock arguably got ahead of itself in 2021 when the stock price nearly doubled from its pre-COVID-19 levels -- suggesting that Disney+, barely a year into launch, should be worth the same as Disney's existing empire.
The reverse effect happened on the downside when Disney stock began to fall, and perceptions of Disney+ flipped from optimism to pessimism. Disney+ is not yet profitable, and management doesn't expect it to be until fiscal 2024 at the earliest. After all, tolerance for any free-cash-flow-negative endeavor is low during a period of rising interest rates and a potential recession.
As bad as the short-term outlook is, it's important to remember that an economic recession is nothing new to Disney. And the company is used to investing through downturns by expanding its parks and funding new films. So even if it takes Disney+ a few more years to be profitable, it's a goal the company's investment-grade balance sheet and brand power can achieve.
But for traders who only invested in Disney due to the once red-hot allure of its streaming platform, the stock doesn't look as attractive as it did during the hype of early 2021.
For now, Disney stock probably never should have climbed above $200, but it also doesn't make sense that the business would be worth the same today as it did eight years ago, given the impressive growth of the company's overall business in the past decade (plus the long-term prospects of Disney+).
A better approach to investing
Countless other well-known blue chip companies experienced a whipsaw in their stock prices similar to Disney. There are a few lessons to glean from the past few years.
The first is that trading a stock based on themes and momentum instead of the long-term investment thesis is a fool's errand. Rather, it's better to hold quality companies through periods of volatility and regularly add savings to companies you believe can compound returns over time.
Second, you can avoid many mistakes in the stock market by digesting news and following current events without letting them fundamentally alter your investing strategy. Put another way, you can stay informed without acting on impulse.
The fight-or-flight instinct can balloon in a bear market. Some folks try to fight a downturn by trading their way out of it, borrowing money on margin, or resorting to risky options. Others choose flight by selling good stocks at bargain prices.
Oftentimes, the best course of action is to stick to your long-term game plan and take action not through trading but through learning and building knowledge. I find that control is a coveted resource during a bear market. And while investors have no control over the macroeconomic environment, knowing what's going on provides a sense of security that can be comforting when asset prices are falling.
Understanding what's going on and how those inputs can impact a stock price in the short term will be an empowering tool to deploy in 2023 and throughout your investing journey.
