In the markets, the first week of 2016 hasn’t exactly been what I would call perfect. In fact, depending on which metric you use, the domestic market, as defined by the S&P 500, is down 5.96% during the first full trading week of the year.
Not quite what we had hoped for to launch 2016.
So where do we go from here, you ask?
In my opinion, we go back to the basics. The basics that tell us not to overreact to short-term movement in the markets. The basics which suggest that long-term investing, while difficult in a market of short-term volatility, is often one of the best strategies to follow.
In addition to the basics, here are five key mistakes I suggest to avoid early in 2016.
1 – Selling your Investment Out of Fear
A recent Dalbar study suggests that the average investor averaged 5.19% over the past 20 years to the end of 2014. During this same period, the S&P500 earned 9.85%.
To put it another way, in the past 20 years the average investor has underperformed the S&P500 by 4.66% per year. What is to be made of this difference? Is it fees? Certainly there must be something that the average investor doesn’t know.
It’s simple actually. Per the article, the average investor makes the mistake of getting in their own way.
During periods of market volatility (like the first few trading days of the year), the average investor often sells their investment, often out of fear, when the market is down (selling low) and re-enters the market by buying after the value has gone up (buying high). This psychological and behavioral decision-making could drive the average investor to do exactly what we are trying to avoid—buying high and selling low.
Good investing should be the opposite, buying low and selling high.
Unfortunately, volatility, like we are experiencing now at the start of 2016, may drive investors to do the exact opposite.
2 – Stop Contributing to Your 401(k) Plan (or other investment accounts)
Investors don’t like to lose money. That feeling seems compounded when they contribute money to a 401(k) plan, only to see the account balance continue to decline. Not only are they losing money on their existing balance, but their savings are being washed away too!
Not a good one-two combo.
But keep your hopes up. Investing in periods when the market is down means buying low. As the value of the shares drops, your systematic savings (via your 401(k) contributions) allow you to buy more shares at a lower price. The end result of this means a lower average cost (this is known as dollar-cost-averaging, another great financial planning tip).
Historically, investments in the markets make money over time. While this isn’t guaranteed, we are all hoping and expecting this to happen with our 401(k) and other retirement accounts. That is why we invest.
Considering there is no need for this money now, there is a want and a need to save for retirement, and the opportunity exists to buy shares “on sale,” continuing to make contributions to your 401(k) is the smart thing to do.
3 – Think Just Because the Value of an Investment is Down, It Has to Come Back Up
As recently as a few months ago, oil was priced at a “bargain” at $60 per barrel. Certainly, some investors thought, oil couldn’t be this cheap and would climb back up to over $100 per barrel.
Unfortunately, this wasn’t the case. Oil is now hovering at $33.16 per barrel range as of January 10th 2016. Those investors who were sure the price was going back up and bought at $60 may have suffered a near 50% loss.
So is now the best opportunity to buy? If $60 was a “good” price, then $34 must surely be, right? Maybe, but maybe not. Has it hit bottom? How much further can it go? When will it turn around? When will it get back to $60 per barrel, let alone $100 per barrel?
We discussed the 50% drop from $60 to $30. But to go from $30 to $60, it needs to go up by 100%, to double your money. Not an easy task. And maybe not a task that is accomplished in the short term.
4 – Believe You, Or Anyone, Knows Exactly What Will Happen Next
As market volatility increases, unsolicited opinions from experts and non-experts seemingly increase as well. Everyone thinks they are an expert. Everyone thinks they know what will happen next.
Here’s a secret. No one knows exactly what will happen next. If they did, they would lock that information up in the most secretive box ever, only to capitalize on it at the perfect time, making potentially millions and millions of dollars.
Let me ask you this—if you knew exactly what was going to happen and knew you could profit from it, would you be willing to share this information so freely?
Still, there will be “experts” all over. Some are paid to have opinions (see your local/national news), and others will be your friends and family.
A good strategy may be to politely ignore these experts and focus on the keys of good investing: diversification*, asset allocation, and long-term investing.
5 – Think This is Something that Hasn’t Happened Before
It is normal for markets to experience volatility. Volatility goes hand in hand with investing. Volatility over a few days, a few weeks, and a few months. It just so happens that this volatility has occurred at the beginning of the year when we mentally reset our starting point.
In fact, JP Morgan suggests that the markets (as defined by the S&P 500) decline on average 14.2% per year. Looking at the previous 35 years ending 2014, we notice that 27 of the 35 years produced positive market results. Even so, the average intra-year decline during these 35 years was 14.2%. So while the markets did well overall, they seemingly always had periods when the markets were down. Depending on how you define it, sometimes they were arguably significantly down.
This year, 2016, we are off 5.96% on the S&P500. That doesn’t mean it cannot or will not get worse. But it does mean we are well below the “average” while well within a “normal” range of volatility.
And it does mean that we shouldn’t overreact to the short-term market movements. Instead we should focus on our long-term investment goals.
What Should We Do?
Nothing…. just maybe. Do nothing.
If your risk tolerance hasn’t changed – if your asset allocation is appropriate – if your goals and objectives are consistent, then doing nothing may very well be the right answer.
It’s ironic, because during times of market volatility our reaction is often to do something. By doing something we think we can control the outcome. Unfortunately, history will tell us that the outcome may often be a lower rate of return over the long run.
On the other hand, it may make sense to do something. This may mean rebalancing your account, changing a position for the right reasons, or reconsidering your risk profile if the volatility is too much.
So what is the right answer? That depends.
But the right answer is likely one that is a rational decision made with the readily available information on hand. Not one that is acted upon primarily through the instant fear felt via a poor start to the New Year.
*Neither Diversification nor Asset Allocation guarantee a profit or protect against a loss.
S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. Investors cannot invest directly in an index. A plan of regular investing does not assure a profit or protect against loss in a declining market. You should consider your financial ability to continue your purchase through periods of fluctuating price levels.