Investing through market volatility can be challenging. Should you go to cash? What investments perform the best during a market selloff? Is it a good time to consider buying the dip? Often, the best time to evaluate or make changes to your portfolio is before volatility arrives, not after. If you’re unsure whether you should take any action, then you probably shouldn’t. Staying the course through market volatility usually rewards the patient investor. Here are the two biggest mistakes investors make during a market ‘crash’.
Selling to cash
The biggest mistake investors make when stocks fall is to cease being an investor and sell to cash. Why? Because it’s practically impossible to perfectly (or even adequately) time your exit from the market and your re-entry. Investors often focus on selling and give little thought to when they put cash back in the market again. This is a big mistake.
The graphic below from Morningstar is one of my favorites. It shows the impact of being out of the stock market (FTSE/JSE ALSI) over the last 26 years. Missing just the 25 best days over the last two decades would yield an ending portfolio worth over 50% less than a fully invested account. That equates to an average performance gap of almost 5.9% – per year!
Forgetting to diversify
Diversification isn’t a magic bullet, but it is perhaps the best tool investors have to protect their portfolio from volatile markets. At the most basic level, adding bonds to a portfolio can provide stability and income. But this is just the tip of the iceberg. Asset classes respond to market conditions differently. Further, the correlation and diversification properties within an asset class are also critical to managing market volatility.
The goal of diversification is to smooth investment returns over time and potentially even outperform a concentrated portfolio as a result. As investors move through life, limiting downside risk can become more critical than further upside. This is particularly true when beginning to draw from your portfolio in retirement. By taking steps to limit wild swings in your portfolio, it increases the odds you’ll have the fortitude to stay the course.