Avoid locking in your losses

In time, the ‘market’ (for representative purposes we use the US S&P 500, the largest and most liquid stock market index) has shown persistence in shrugging off concerns that at the time seemed insurmountable.

Remember that by selling a holding for less than they bought it for, investors will be locking in losses which are irrecoverable. They will not be able to participate in any subsequent share price recovery unless the decision is made to replace the holding with another bought at a higher level, which may adversely impact their stock and portfolio returns.

Key investment principles

Stock price volatility is normal

And not necessarily ‘bad’. Buying when markets and stocks are in ‘sell-off’ mode can provide attractive entry points and support longer term performance when markets recover.

Successful investing is not easy

There are many factors that influence stock pricing and sentiment, including macroeconomic factors such as geopolitics and economic conditions, as well as sector and stock changes and news flow. Regulatory changes at the supranational or national level can often exert a significant impact on investor behaviour. Remember that successful investing is a long-term endeavour and can be difficult; if it was easy, everybody would be rich.

Invest for the long term

A long-term investment is one held for a minimum of five years but preferably much longer e.g. assets held to retirement. Historically, stock markets go up over time, but this doesn’t mean all stocks will rise or outperform as a result. Diversification, or spreading wealth among different sectors, geographies and industries, can help to offset some of the unforeseen risks associated with stock-market investing. Viewing investing as a marathon rather than a sprint will also minimise the pressure to take an emotionally-driven short-term decision.

Behavioural bias

Loss aversion bias is a psychological state when investors are affected more by investment losses than by the gains. This is a refinement of the ‘fight or flight’ instinct which has evolved since the dawn of mankind, when making the wrong move could have proved fatal. A loss-making trade will not prove life-threatening today, but in many cases an investor’s instincts will be to deal with the problem created, rather than focusing on the possibility of a recovery in the longer term.

Time in the market vs. timing the market

It shouldn’t come as a surprise, but alongside the reality that investing is hard are various studies showing that trying to time the market by staying in cash or waiting for a correction before buying can significantly underperform a ‘buy and hold’ strategy.

Research covering almost a century’s worth of US market data up to 2011 showed that a 20-year holding period never produced a negative return.¹  More recently, Morningstar’s annual ‘Mind the Gap’ study of returns showed that investors earned a respectable 6.3% per year on the average dollar invested in mutual funds and exchange-traded funds over the 10 years to 2023.²  This was 1.1% per year less than the average fund’s total return over the same period assuming an initial lump sum purchase. The shortfall is accounted for by poorly timed fund purchases and sales.

The power of staying invested

The market’s best days often occur right after its worst days. By staying invested through volatility, investors can remain positioned to capture the recovery – while investors who fail to get back into the market at the right time can miss out on the full benefit of the recovery.

The chart below shows the difference between investors in the MSCI All Country World Index (ACWI) who remained fully invested over the past decade and those who have not - missing out on a handful of the best return days can have a significant impact on eventual returns.