Current Market Conditions Encourage Bad Decisions – Don't Make The Same Mistakes

My job has good and bad periods, and when the markets are up, everyone loves me and I hear nothing but good things. But at the same time, as soon as the markets begin to show some weakness, my phone is ringing constantly with worried investors. While you can occasionally talk some sense into certain people, others just go off and make irrational decisions.

First Negative Return on a Quarterly Statement

For most types of accounts, quarterly or annual statements are coming out, or have just recently come out. For the past few years, this usually brings excitement as investors can smile about how much their account grew. Unfortunately, for many people the fourth quarter of 2007 brought with it the first overall negative return in years. The S&P 500 closed out the last quarter with a little over a 3% loss, so those who had most of their investments in domestic stocks saw a hit. In fact, even those with some bond holdings probably also a decline.

This really just goes to show you how short-term people generally think when it comes to investing. If we look at the S&P over the past five years, or 20 calendar quarters, only five quarters saw a loss. And even then, the losses were quite small, generally ranging from around -1.5% to -3.3% . Considering most people have a fairly diversified portfolio with some bonds, small cap and international stocks, the typical person didn’t see 5 losing quarters over this period.

But instead of people remembering how they have made excellent returns over the past five years, they begin to overreact as soon as a negative number pops up on their statement. Forget about that 11% annualized return they’ve realized over that period, but instead they focus on the couple percentage points they lost in the last three months.

I’ve Seen Some Drastic Measures Taken

This market has driven some wild behavior. In just the past few weeks I’ve seen people do everything from going into 100% bonds at age 25, to those who recently retired completely cashing out their entire retirement account balance. It is truly amazing how certain people react, and no matter how much you try to rationalize with them, they insist that what they are doing is in their best interest.

Don’t Make Drastic Decisions Based on Short-Term Market Conditions

Remember when you proudly did your research and developed a decent asset allocation? You did that asset allocation specifically to address times like these. By diversifying your investments, you intend to maximize your return while minimizing risk. That doesn’t mean that you’ll always see a positive return and it doesn’t mean that you’ll always meet or exceed what the market does. Unfortunately, a lot of people think that by adding some bonds or cash to their portfolio that it will protect it enough from loss. While they can help offset market losses, the long-term benefits of fixed investments aren’t always noticed on quarterly statements.

It is perfectly reasonable to take a look at your portfolio and determine if there are any minor adjustments to be made, but if you’re already in a suitable allocation, you shouldn’t make any major changes. The last thing you want to do is move from an 80/20 equity/bond mix to a 20/80 mix just because the market is shaky right now. All you’re doing is locking in the short-term losses you’ve experienced and trying to time the market by hoping that the market keeps going down. It has been written about numerous times, but for most people, market timing simply doesn’t work.

So, don’t make any drastic decisions based on the past few weeks and instead, think back to what you’ve seen over the past few years. Is your 5% loss in the past month really that bad considering you made 50-60% over the past 5 years? Just keep in mind that you can’t always expect to see 8-11% returns each year, and that is why they are called averages. Sometimes you’re up, sometimes you’re down, but we know from history that if you’re in long enough, you’ll be up.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.