Market downturns can be scary when you’re invested in the stock market. Watching your hard-earned nest egg drop in value by a double-digit percent makes many investors’ stomachs drop like they’re headed down the steepest drop on a roller-coaster ride. That feeling can lead to some major money mistakes if you let your emotions rule your money choices, though. Here are four mistakes many investors make when thinking with their hearts, and not their heads, during market downturns.
Mistake #1: Selling low.
Coming back to my roller coaster analogy, this is the equivalent of jumping off the rollercoaster after the big drop – except instead of you going splat, it’s your investments that suffer the consequences. Selling off after a drop guarantees that you’ll lose money. In finance speak, that’s called “realizing your losses” – in other words, they’re not real until you sell.
That’s because the market always bounces back after a period of losses. You can’t benefit from that recovery, though, if you’re not still in the market when it happens! Selling when times are rough is a sure-fire way to lose money.
Mistake #2: Staying in cash after selling low.
This one is a one-two-punch when combined with the first big mistake. After selling low, many investors will leave their money in cash while they wait for times to get better. In doing so, they miss out on that fantastic recovery period where your investments go back up in value.
And what happens next?
If they have the guts to get back in at all, they end up buying when the market is already on the high side of things, setting themselves up for yet another downturn. It creates a vicious cycle of buying high and selling low – exactly the opposite of what you want to be doing.
This whole thing is made even worse by the fact that inflation is as high as it is right now. Remember: the entire time your money is sitting under your mattress, inflation is constantly working to make it worth less, and less, and less. So not only do you not benefit from the market recovery by keeping money in cash, but you actually guarantee it will be worth less than it was before you sold everything off.
Mistake #3: Catching the falling knife.
I actually made this mistake myself when I bought Air Canada at the very onset of the pandemic.
The term “catching the falling knife” refers to trying to time an investment so that you’re buying when it’s at a low point, in order to benefit from the gains when it recovers.
The problem is that most people, myself included, aren’t great at judging the value of a stock, and so they base their judgment of whether something is “a deal” on how low the stock has dropped from its recent high point.
In my case, I started buying Air Canada at $37 a share, which was down from its high point of $50. I thought it was great value and well… I was very, very wrong, lol.
Trying to time a dropping investment is called “catching a falling knife” for a reason – it’s extremely risky, and you’re as likely to hurt your investments as you are to benefit. If you do get it wrong, you then become extremely likely to make mistake #4.
Mistake #4: throwing good money after bad.
Ok, so you tried to time an investment, only to find that you got it wrong, and it kept dropping. Now what? In this situation, many investors try to “average down” – that is, they try to bring down the average cost of their shares by buying more as the price keeps dropping.
But what happens if the investment you’re buying is on its way to zero? It doesn’t matter what price you bought at then; you investment return is going to be -100% either way.
This behaviour is called “throwing good money after bad” because you wind up putting in fresh investment money – money you could have put to work for you elsewhere – into an investment that is just going to keep losing you money. This is the same thing gamblers do at the casino when they try to “win back their losses” – they think that, by putting more money in, they can somehow turn a profit.
Some investments are just stinkers though, and you’re better off cutting your losses and putting your money elsewhere.
As an aside, this is why I don’t generally invest in individual stocks (Air Canada was the lone exception) – it’s too easy to fall into one of these traps and wind up playing a loser’s game.
What you should be doing instead
You have a number of options available to you when the market experiences a downturn. I’ll give you two easy ones.
Option #1: do nothing. That’s right, don’t change a thing. If you’re invested, stay invested. If you’re putting money away monthly, keep putting it away monthly. Just keep doing whatever it is you’re doing, and not only will you weather the storm, you’ll actually come out better for it, because you kept putting money in while the market was down – in other words, you were buying low!
Option #2: Buy more than you were before. When your favourite clothing store puts a sale on their clothes, do you complain? Hell no! You go into the store and buy, because you’re getting a good deal. The same is true for the markets. When they’re low, if you can afford to put more money in, you can actually wind up beating the average market return.
Now I know what you’re thinking: this sounds a lot like throwing good money after bad. But that’s not true if your investments are properly diversified. If you’re investing in index funds, for example, there are so many companies built into your investments that there’s basically no chance that you’ll lose everything. If that does happen, we have much bigger problems to deal with, because it means that an entirely country is on the brink of collapse.
Anyway, it’s not throwing good money after bad if you’re properly diversified. In fact, doing this is one of the main ways I’ve managed to keep my annual portfolio performance above 12% on average over the past 10 years.
Wrapping it Up
Market downturns aren’t easy for anyone. But with the right mindset, you can weather the storm without shooting your future self in the foot by making the mistakes mentioned in this post. Remember: every thunderstorm eventually passes, leaving behind sunny days and a brighter outlook ahead!