Finding good investments isn’t the hard part… The hard part is not screwing up.
That’s because investing is a “loser’s game.” And in a loser’s game, skill won’t always lead to success.
In fact, in a loser’s game, you shouldn’t focus on trying to win. You should focus on minimizing mistakes.
Amateur tennis is the most famous example of a loser’s game…
Hitting the ball across the net is no easy feat when you’re new to the sport. As players get a bit better, they want to hit shots the opponent can’t return. That’s where it gets tricky, though.
The more difficult the shot, the more likely the player is to make an “unforced error” – like hitting the ball out of bounds. You start trying to play like a pro, but you’re not ready for it yet.
The best amateur tennis players know not to focus on playing harder. The easiest way to win is avoiding mistakes and letting your opponent make those unforced errors.
That’s how you beat a loser’s game… Go easy, and don’t make mistakes.
Investing is a type of loser’s game, just like tennis. If you want to earn great returns, you need to keep your emotions in check…
Panic-selling is one of those classic mistakes. And a lot of folks made that unforced error when fear spiked earlier this month.
Hopefully you avoided this trap. The market has already recovered most of its losses. And history shows this type of recovery is normal.
What’s more, as I’ll explain, selling after a bad day is one of the worst things you can do as an investor. It’s a swift way to cut your long-term returns in half – or worse…
Fear took the reins earlier this month. The S&P 500 Index lost 6% over a three-day stretch and dropped 8.5% from its July high.
That coincided with a massive spike in the CBOE Volatility Index – the market’s “fear gauge.” And it left folks wondering if this was the start of a new bear market.
I’m sure plenty of investors took the bait and sold as the mayhem unfolded. It probably felt like the right call at the time.
Selling in a tense moment means you’ve stopped the bleeding. It feels like you’re protecting yourself. But here’s the problem…
Panic-selling is the easiest way to destroy your long-term returns.
To see it, let’s imagine you sold stocks every time the market had a bad day. Then, you waited two weeks for the dust to settle before buying back in.
Over the past 30 years, stocks have fallen 2% or more in a day about 4% of the time. We’ll use that as our threshold. So after every daily loss of 2% or more, say you sell stocks and sit out for two weeks. Then you buy back in.
This idea might seem reasonable. It allows you to take a breather in rough times. And you know exactly when you’re buying back in.
Still, reasonable or not, it’s a horrific investment strategy.
The S&P 500 went up 8.7% a year over the past 30 years. If you’d followed this strategy, your returns would have dropped to just 4.6% a year. That’s massive underperformance. And it compounds against you over time.
If you’d invested $10,000 in the S&P 500 30 years ago, it would have grown to around $121,000. But with a panic-selling strategy, your $10,000 investment would have turned into just $39,000.
Said another way, if you consistently panic-sell, your long-term returns would be 68% less than if you’d just held stocks through the volatility.
The problem with panic-selling is twofold…
First, you spend more time than you might expect out of the market. This strategy would have left you uninvested about 25% of the time over the past 30 years.
The second problem is worse. Markets tend to rebound quickly after bouts of volatility. So if you panic sell, you’re missing those recoveries.
We’ve just seen that recovery in action. Stocks fell nearly 3% on August 5. Two weeks later, they’d rallied more than 8%.
If you’d panic sold, you would have missed out on those gains.
Successful investors understand that they’re playing a loser’s game. It’s not about making the best decision every time. It’s about always avoiding the catastrophic mistakes.
Panic-selling is one of those mistakes. I hope it didn’t get you this time around. But if it did, you don’t have to make the same mistake next time.
Decide on your strategy in advance, and stick to it… even when emotions are running high. Your portfolio will thank you for it.
Good investing,
Brett Eversole
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Source: Daily Wealth