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WHO SELLS STOCKS IN A DOWNDRAFT?


By , with Annuity FYI

(EDITOR’S NOTE: Over a long span of time, research shows the average investor – one who invests in a mix of stock and bond funds – does not even average a 3 percent annual rate of return. This has been true over the last 10, 20 and 30 years. Why so bad? Over long stretches, stocks, including dividends, have produced roughly a 10 percent annual rate of return. If you’re also investing in bonds, which by one measure have returned an average long-term return of just under 6 percent annually and far less in recent years, you obviously won’t attain this lofty return. 

Still, why such pathetic annual rates of return? It’s largely because investors panic when the stock market drops and make the huge mistake of selling low. And according to some serious research on this topic, among those who often make this mistake, hard though it may be to believe, are the wealthy.)

In early 2022, there was a serious sell-off in the stock market, sparked by an unusually sharp uptick in inflation and multiple proclamations by the Federal Reserve that it would soon start hiking interest rates. In just one month, most major indexes exceeded or approached a formal stock market correction – a decline of at least 10 percent from the high– and prospects for the months ahead similarly seemed bleak.

It appeared that most investors were selling and that the biggest sellers of all might have been older folks and the wealthy, based on a research paper written by 10 economists and an IRS analyst about the 2008-2009 market crash and recession – the worst this century. (The paper was entitled, “Who Sold during the Crash of 2008-2009?”) 

If true, the heavy selling more or less made sense for the older set. They tend to be conservative in the first place and favor bonds over stocks, and there is additional incentive to sell amid a market sell-off because most live on fixed incomes and thus have less opportunity to make up losses by continuing to work. But while the research paper said the sellers in a tough market also tend to be wealthy, that raised unanswered questions. Shouldn’t the wealthy be accustomed to the ups and downs of markets, which probably helped many of them get rich in the first place?

The research paper came up with no good answer — and that, by itself, says a lot. Specifically, it underscores that too many investors are in fact traders and panic in bad times at their own expense, given that the stock market has always set new record-highs over time.

To cut to the chase, too many investors don’t know when to sell a stock. Too often, they fail to embrace the reality that the ability to make money involves two key decisions – buying at the right time and selling at the right time. To make a profit, you have to execute both of these decisions correctly. 

As the wealthy investors mentioned in the aforementioned research study apparently underscore, buying a stock is relatively easy but selling is a more difficult decision. If you sell too early and the stock market goes higher, you risk leaving gains on the table. If you sell too late and the stock plunges, you’ve probably missed your opportunity.

Regarding the timing of selling, the real question is the investor’s reason for selling or not selling. There should be a good fundamental reason to sell a stock. Any number of extrinsic reasons may also make sense, such as a need to sell a stock to book a loss for tax purposes, or because cash is needed to deploy in a competing investment, such as real estate. Or if you’re a younger investor, you might consider selling all or part of your portfolio to make a down payments on a house or to buy a car.

The point is that you should have a respectable reason to sell. The fear of losing money doesn’t fit this bill. This isn’t a good reason because it challenges the wisdom of buying the stock in the first place. Most important, it often leads to regret because good stocks tend to rise over time amid ever-changing market forces. 

The biggest problem with selling – especially if you fell a substantial portion of your portfolio in a bear market – is that it’s extremely difficult to determine when to move back into the market. Fact is, many panic sellers don’t reinvest in the market after moving into cash, even though some of the best returns have followed the biggest dips, according to research by Bank of America.

If it turns out that you simply can’t stomach market swings, then you should strongly consider pivoting to less stock exposure. But first ask yourself if there has been a change in your core financial values, goals and reasons for investing. If the answer is no, it might be best to strongly reconsider your fear of loses and learn to stick it out in the market, volatility notwithstanding.

Regardless of your strategy, it’s important to try and learn from previous mistakes. Because as already mentioned repeatedly, the data shows that your pot of money will grow if you stay invested.

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