Opinions expressed by Entrepreneur contributors are their own.
The first thing people do when they see a big drop in the stock market is panic. Fear sets in, and everyone starts to react emotionally instead of logically.
Let’s take a look at three of the most common mistakes investors make during a down market.
1. Liquidating long-term investments
One of the first things people do when they see big drops in the stock market is rush to sell their long-term investments. The truth is — you should probably be looking to purchase more of those long-term stocks instead of selling off the positions you have. When you take a position in a long-term investment, you need time in order to benefit from the investment. So what happens today doesn’t matter as much as what happens seven to ten years from now.
If you have additional funds, one of the options you have during a down market is to add to your long-term investments. By adding shares, you bring down your initial cost basis, which provides you with a better entry position. For example, if you have 100 shares of XZY company at $50 per share and the shares drop to $30 per share, purchasing 25 more shares would bring your cost basis to an average of $46 per share. That’s a $4 gain per share from your initial position on 125 shares.
Now, why would you want to add to your long-term positions if the market is falling? Well, that brings us to mistake number two.
2. Thinking the market will continue to fall forever
Many people overreact to major swings in the stock market because they don’t understand how the market moves over long periods of time. Since 1928, the S&P 500 has reportedly experienced 26 bear markets. The average loss of stock value was approximately 36% each time. Bull markets have always followed a bear market, and during a bull market, the stocks gain approximately 114%. History shows us that there’s a benefit to holding and possibly adding to your long-term investments during bear markets.
The stock position’s growth during a bull market exceeds the stock position’s losses during a bear market. So why do so many people lose money investing in the stock market? That brings us to mistake number three. Not understanding a long-term investment versus a short-term investment.
3. Overlooking the difference between a long-term investment and a short-term investment
When you take a position in a stock for a long-term investment, time is your ally. The major U.S. stock indexes — including the Dow Jones Industrials, S&P 500 and Nasdaq — have all trended upward since their inceptions. Even after historic bear markets like the Great Recession, the “Black Monday” crash of 1987 and even the Covid-19 pandemic. Based on all historical data, entering into a long-term investment in a U.S stock index should yield a profit over time. Warren Buffett, the ultimate buy and hold investor — and one of the greatest investors in history — is famous for picking fundamentally strong stocks that are trading at a discount to their intrinsic value during bear markets. His approach to investing is perhaps best summarized by one of his most famous quotes: “Be fearful when others are greedy, and be greedy when others are fearful.”
Related: How To Start Investing
So how do so many people lose money in the stock market? That answer can be found primarily in short-term investing. Because of the volatility in the stock market, short-term investing can be very dangerous. As previously stated, if you invest in a major U.S. index for more than seven years, there’s an excellent chance you’ll have a profitable investment. However, when you invest in random companies for short periods of time, there’s a much bigger risk of losing money. Even major blue-chip companies have good and bad days. Suppose you are entering and exiting your positions on a short-term basis, like, monthly or daily, you may get caught up in a bad day, resulting in a loss of money from your investment. The biggest issue with investing on a short-term basis is experience. If you are a seasoned, experienced stock trader, you can make a very profitable living trading short-term, but as the old saying goes, “the bigger the risk, the bigger the reward.”
Long-term investing is still the best way to beat the market
In conclusion, when investing in the stock market, you have to be prepared for ups and downs — bull markets and bear markets, good days and bad days. If you have the experience, you can take calculated risks on short-term investments. However, if you want to play it safe, based on all historical data, you can’t go wrong with a long-term position in a major U.S. stock index. The average bear market lasts approximately 289 days or just under 10 months, and the average bull market lasts around 973 days or 2.7 years. But, let’s not forget the longest bull market in history, which lasted from 2009 to 2020 and resulted in stock growth of more than 400%. So remember, when in doubt, time is on your side.