Investment Mistakes to Avoid: Panicking When Stocks Decline

Has there ever been a crazier and more volatile time in the stock market than right now?

The short answer is yes, of course there has. Many times, and much crazier.

Our collective memory, however, can be maddeningly short. Stocks took a history-making slide once the pandemic started in March 2020. Then a historic recovery followed.

You only have to go back to 2008 for the most recent big spill, over housing. It’s easy to forget, but stocks also fell in 2015 and 2011 and in 2010 we saw the “flash crash” in stocks that sent shivers up and down Wall Street.

In other words, these things happen from time to time. And we normally forget about them as they become increasingly distant in the rear-view mirror.

So what’s going on? Consider this sage observation: “Every investment price, every market valuation, is just a number from today multiplied by a story about tomorrow.”

The “story about tomorrow” part is the key. Stock prices are not based on the current value of a given enterprise.

Sure, the price represents what it costs to “buy” the company. If you have sufficiently deep pockets, perhaps even control of the whole operation.

But no business owner will sell you an existing business for what it currently produces, today, in terms of revenue and profits.

Instead, the owner will ask a price that reflects some number of years of future earnings they won’t get for making the decision to sell today.

Your task, as the presumptive buyers, is to figure out how long you can afford to run the company to pay off that premium (and any associated interest cost) and begin to make money.

Some companies have a long track record of earnings and can easily demonstrate an ability to continue making those numbers. Others promise fantastic future earnings but right now, today, perhaps can’t.

A number today, multiplied by a story about tomorrow.

When markets get volatile, usually, it’s because some event has occurred that brings into question that story about tomorrow.

It might be the threat of a recession, or the cost of money going up, or in the case of individual stocks, a scandal or revelation about shoddy management.

Repricing exercise

In the same way that faith tends to drive expectations about the future, bad headlines can shake expectations. People go from believing that future story to doubting.

Accordingly, prices “correct” to a more reasonable number. That’s why a market decline is often called a correction. It’s not that prices will fall to zero but instead will fall to some more accurate number.

Put another way, values will begin to reflect a story about tomorrow that more investors believe. Then, typically, prices stop falling.

So what should you do when stock markets are chaotic?

If you own shares, either individually or as part of a fund, remember that market volatility is a repricing exercise. If you’ve been in the investment for a while and have gains, it’s likely that you will still be ahead once the dust settles.

If you just bought the stock, tough luck. But don’t panic and sell as it falls. The only thing you get from that is a guaranteed loss.

Some stocks keep going down, of course. Usually, this is indicative of a company that falls into the fraud or scandal category. It’s not a common outcome but it happens.

To reduce that risk, own fewer individual stocks and instead try to own broad mutual funds or low-cost index funds. Diversification is the key to a better night’s sleep.

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