3 tips to avoid locking in losses

Allen Wastler

By Allen Wastler
Allen Wastler is a former financial journalist with over 30-years of experience, including time at CNBC, CNN, and Knight-Ridder Newspapers.
Posted on Apr 13, 2020

After a huge market downturn and a major loss of value in your investment portfolio, the temptation to do something — anything — may be hard to resist.

But in many ways, the best action may be to take no action. Why? An investment plan is a long-term project and making changes to it based on short-term considerations is often ill-advised. That’s why financial professionals encourage people to stay calm during market sell-offs and think about long-term objectives.

“It is a tough and scary time, and not locking in losses by panic selling is critical,” said J. Todd Gentry, a financial professional with Synergy Wealth Solutions in Chesterfield, Missouri.

But even if you did resist the initial impulse to flee during a market retreat, you still need to keep some discipline about your portfolio as you wait for a market recovery. Here are some traps to avoid.

Chasing investment returns

Selling off your holdings in a market decline is the surest way to lock in losses. A solid investment that was doing well before an unforeseen setback, like a pandemic or financial crisis, can still make a comeback. But if you sell at the bottom, you miss the chance at recovery.

And trading that solid investment for something that appears “hot” can also be unwise, as you might be buying after it has already made its significant gain.

“Don’t chase returns,” said John Ocwieja, a family business specialist with WestPoint Financial Group in Chicago. “And never sell your holdings on a downswing in the market when you are invested for the long term.”

That’s particularly essential for holdings that are generally tied to overall market performance, like index funds. Markets, as a whole, have historically bounced back from downturns with time, as the following chart illustrates.

Source: Bloomberg. The S&P 500 is an equity index that consists of the stocks of 500 large U.S. companies measured by market capitalization. The results here include the effect of reinvested dividends. You cannot invest directly in an index.

This isn’t to say that portfolios and investment holdings shouldn’t be periodically reviewed. But such reviews should be conducted with long-term objectives and asset allocation in mind. Often average investors, who don’t have the time or training to study individual investments in depth, consult a financial professional to help guide decisions.

Market timing

Many people also try to time their buying and selling decisions based on predictions about market movements: buying right before they think the market will move higher and selling just before they suspect a market may move down.

This practice also can lead to unfortunate results, especially for the average investor. Professional stock traders and investment professionals often use in-depth research and statistical models to predict market movements, and yet still have inconsistent results. Indeed, a study by Boston College’s Center for Retirement Research found that the managers of a certain class of mutual funds underperformed similar funds when they tried to time the market.

For average investors, financial professionals typically recommend the opposite strategy, buy and hold. This is where an investor selects investments that are consistent with their risk profile and long-term objectives and keep their holdings for a number of years. Such a strategy can produce steady returns over time. Again, many people opt to consult a financial professional for help in selecting the appropriate investments.

Fees, not earnings

Often, switching investments or changing holdings in your portfolio will result in an administrative fee or sales charge, which lowers your investment return.

Additionally, there may be specific fees for mutual fund investors, depending on the fund. Some mutual funds have early redemption fees in place to discourage short-term investing. Others may have what’s called back-end loads — essentially deferred sales charges to the fund’s broker.

The impact of such fees or transaction costs will depend on the level of activity and the size of the portfolio. For some investors, they could be inconsequential, while for others it may add substantially to investment costs. But all investors should consider them when contemplating changes to their investment mix. Needless or spur-of-the-moment changes could add to costs, possibly without adding much in the way of returns.

Additionally, there is the opportunity cost to consider. Money spent on fees is not earning a return as part of investment principal.

Conclusion

In the end, financial professionals will advise most people that investment moves should be thought out and made in conjunction with an overall financial plan. That includes planning for the future, as well as funds for the short term.

“I have been assuring people we are here and willing to discuss whatever they may need to consider to access liquid dollars to make it through,” said Gentry.

Discover more from MassMutual …

Understanding the basics of investing

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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.