According to an article on BrighterLife.ca by Kevin Press, the bear market is officially here. Markets have fallen over 3000 points from their peak in March and all the gains in the first quarter of the year are gone and then some.
It’s times like these that investors contemplate selling and getting out of the markets. In recent weeks, I’ve talked to a number of investors who are just fed up with markets and mutual funds. And really, who can blame them? Investors have been told for quite some time that over the long term, markets will do better than fixed income investments like bonds or GICs. Unfortunately, that just has not happened. The markets have not had a stellar track record over the past 10 years.
Despite the tough numbers, investors looking to sell today need to understand three really important consequences to selling today:
1. Crystallizing losses and selling low.
We all know the theory to making money in the stock markets – Buy Low, Sell High. Although that makes logical sense, it’s tough to do because times like these when prices are low (20% lower that a few months ago), our gut instinct and emotion tells us to do the opposite.
I’m sure you’ve heard advisors tell you it’s the wrong time to sell. The old strategy of buy and hold says it’s important to have patience and hold and just get through these tough times because eventually prices will come back up. If you sell, you only crystallize the losses. If you don’t sell, the losses are just paper losses. I hate to say it but there is definitely truth to this. The consequence of selling is the crystallization of losses and the likelihood of selling low.
2. What’s the alternative?
So let’s say you sell. Now what? Where are you going to go? Cash is paying you nothing. Interest rates are low so GIC rates pay very little. Bond yields are not much better and carry downside risk if interest rates rise. Will real estate, gold, silver commodities do any better? There’s no guarantee and really the risk of future drops is still there.
One of the consequences of selling today is there just is not a lot of places to go. If you sell at a 20% loss and move to a 2% guaranteed return, it will take 12 years to get back to your original value before losing 20%. Chances are the markets will make back that drop long before that 12 years. I've always been a big fan of GICs but selling to these low returns is not logical.
3. When to get back in?
Some investors argue that they just want to get out ‘for a while’ until things stabilize. I can tell you from my 20 years of experience, this is a losing argument. This is a form of market timing and market timing consistently is impossible. We’ve all heard tales of market timing luck but consistent predictions of future market movements is impossible.
The other problem is psychology works against you. Linear extrapolation is a phenomenon where we, as investors, can’t help but think in straight lines. When something is going up, we think it’s going to keep going up. When something is going down, we think it’s going to keep going down. Look at a market chart over the last day, week, month, year, decade, etc. The markets have never moved in a straight line and never will! The reality is markets always move in cycles. Your gut and emotions will lead you back in once a recovery has started and data suggests that you may miss out on the best returns of the markets.
Don’t fall into this trap. The consequence is too severe.
My two cents
If you are planning to sell, this article is the last thing you want to hear but tough times require tough discipline. Before you sell, take some time and really think about it. Try to be as logical as you can. It will be tough but irrational behavior make create damage that is tough to repair. If you really want to get out, the time to do it is after the recovery is well underway and mark my words it will come. I just can’t tell you when it’s going to happen. But maybe by then your emotions will lead you to a sense of confidence that because things are going up, they will continue to go up. And then we’ll revisit this cycle again!