Three Common Mistakes to Make During a Stockmarket Slump

When the markets move against us, it can be a time when emotions start to rule and we can make some mistakes that are obvious in hindsight but not always clear in during periods of uncertainty.

What a difference a few weeks make. One minute we’re high on a bullish market, riding a global equities Trump Bump, the next we’re crashing down to earth in a coronavirus slump. As you can see from the sudden plummet on the graph below showing the NZX 50, the main stock market index in New Zealand, investor confidence also fares poorly when contaminated by COVID-19.

 

The precipitous drop in the market has made it a very uncertain time for investors. And while some people have been queuing outside supermarkets to panic buy toilet paper, pasta and rice, others have been rushing to dump their shares.

The more people rush to sell, the lower prices drop and, before you know it, quickly everyone’s staring down the barrel of a full-on market crash. But before you rush to sell, it’s worth considering some of the most common mistakes made by investors during stockmarket slumps.

Mistake #1: Selling at the bottom

Often the more money that’s at stake, the harder it is to avoid, as many investors start to wonder if the fall will ever stop. It’s in these times that historical returns could be worth considering. There are two things that investors need to be mindful of to avoid selling at the lowest point.

Firstly, avoid measuring off the high

Everything seems more dramatic when measured against the high-tide mark of a stock price. When the ship feels like it’s sinking, the two points to hold onto are the price at which the stock was bought and its 12-month average price. These provide a more level-headed view of how much a portfolio has actually moved. If you’ve been holding the stocks for a while and have been receiving dividends, then you may want to include that in the calculation as well.

For example, if $1000 worth of shares over 10 years have paid out a 10% grossed-up dividend each year, then the received $1000 in dividends means the initial outlay has already paid itself back. If the shares are now worth $500 then you’re still ahead.

Stock market crash
When the stock market’s down, do your emotions get the better of you?

Second, do the maths

Often the market can have an indiscriminate sell-off due to factors not necessarily related to an individual stock. When the price of a stock goes down, keep crunching the numbers to try to come to a value of the company.

The questions you may be looking to ask in these times could include:

  • Has the business model fundamentally changed?
  • Has the book value of the company changed?
  • Is there any new information that makes you consider deviating from your original valuation of the company?

If there isn’t anything material that has changed, then it may be a good time to hold on and ride out the downturn. In fact, you may even want to consider a strategy called dollar-cost averaging while the price is moving down.

Remember, once you sell a stock you are locking in any gains or losses that you have accumulated up to that point.

Mistake #2: Not selling at an opportune time

Of course, individual stocks don’t always just drop with an overall market shift like the GFC or what we’re experiencing now with COVID-19. They can also be sold down due to specific industry or company-related issues.

When specific stocks have declined further or outside of their peers or industry, then it generally means that something has changed in the way that other investors are valuing the company. It’s at these times that revisiting your narrative around this stock is important. Why did you originally invest in the company, what are you expecting to happen to create further value and have any of these factors changed?

If your narrative no longer holds true then it may be time to re-evaluate that stock. Warren Buffett once said that his favourite holding period is forever. However, as the fundamentals of a company and environment around that company change, so does his evaluation, which may lead to a decision to sell the stock.

Market downturn mistakes
Have you made these mistakes?

It’s never easy offloading shares at a loss, but doing it where necessary may be one of the most important disciplines that investors need to learn. If your assessment of the company has changed for the worst and you have ongoing concerns, then not selling could leave you open to:

1) Further losses as the stock may continue to decline over time; and

2) Those funds being tied up in a stock that has limited growth or earnings potential when it could be put to work in a better performing stock.

However, not all stock-price-declines mean that the company has lost its mojo. If you redo your sums on the company and find that they still look good, then it may be an opportunity to buy more of a great stock at a low price.

Mistake #3: Bargain shopping without prior research

Buy low and sell high, that’s a common mantra of stock investors. So, does it make sense to jump in on a stock if its price has been beaten down? Short answer: not necessarily.

Really this point is the summation of the last two points – don’t make decisions on price alone. Instead, do your research. To this point specifically, think about the difference between growth and income stocks.

One of the challenges with pricing growth stocks is estimating the value of future opportunities, such as penetrating a new market or launching a new product. This can cause a growth stock’s share price to move around dramatically, particularly if they’re already trading at a very high price-to-earnings (PE) ratio.

Stock market mistakes

Common investing mantra: ‘Buy low and sell high’

The point here, though, is that following the ups and downs of the stock price in high-growth companies can provide opportunities to buy at a valuation that you’re happy with. Maybe the price never gets to what you deem as reasonable, and that’s okay too, as it will keep your money freed up for other opportunities.

Share price declines in large, quality companies with a history of paying dividends could also present a buying opportunity in some cases. As their share price goes down, their dividend yield goes up, as dividends are paid in cents per share. Provided the company’s ability to pay dividends at the same rate isn’t impeded in any way and the fundamentals of the company are still strong, then investors may be able to walk away with a high-yielding, quality investment.

To sum up

The three points above may seem a little contradictory on first glance – don’t sell unless you should and don’t buy unless you should. But they all hinge around one central point which is to not necessarily just follow the market without doing your research. When the market is determining the price of that stock, industry or sector it can be for a whole host of reasons that aren’t always related to why you’ve purchased the stock or why the stock is good or bad.

Perhaps it should be summarised as something like this: don’t buy or sell based on price movements alone. Instead, re-evaluate the opportunity in light of the new price and decide to sell, hold or buy on that basis.

It’s the same level-headed advice your need to consider when looking at your KiwiSaver balance. In a special update, on March 20, the Financial Markets Authority (FMA) reported that while “many KiwiSaver members are taking heed of the advice to stick with their long-term investment strategy” there had been reports of “a significant increase in switching activity – mostly from growth or high-growth funds into conservative funds”.

This type of knee-jerk reaction is understandable. If you’re watching your investments rapidly decline in value, why not shift to a lower-risk fund profile? But the advice from the FMA and the various KiwiSaver providers, including Milford Asset Management, is to keep a level head.

It’s worth remembering that KiwiSaver is a long-term retirement savings scheme. Historically markets have a tendency to bounce back, and once you’ve sold up and transferred your funds, any losses you’ve made will be set in stone.

If you want to compare the performance of different KiwiSaver providers, Canstar has a free comparison tool, just click on the button below.

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