5 Things To Avoid During A Market Downturn & What You Should Do Instead | Money Mind | Stock Market

Key Concepts

Panic selling, recency bias, volatility, bargain stocks, value traps, inflation, diversification, anchoring bias, time in the market vs. timing the market, US tariffs impact.

What Not to Do During a Stock Market Plunge

Don't Panic Sell

• The primary advice is to avoid panic selling. An example is given of US stocks recovering after an initial plunge following Donald Trump's tariff announcements.
• Panic selling is often driven by sentiment and recency bias, where recent market downturns disproportionately influence investment decisions.
• The analogy of sales in shops versus investment markets is used: people rush to buy when things are on sale in shops, but run away from investments when markets are down.
• History suggests that markets tend to recover and edge higher over time.

Avoid Value Traps

• Careful research is crucial to avoid "catching a falling knife," which means investing in companies that appear cheap but have underlying fundamental weaknesses.
• Value traps are stocks that seem undervalued but fail to deliver expected returns.
• Reasons for value traps:
  • Declining business models.
  • Outdated products or services.
  • Intense competition or industry downtrend.
  • Falling revenues, profits, and shrinking free cash flow.
• It's important to assess a company's earnings power, management effectiveness, and debt levels.

Don't Overemphasize Cash

• While going to cash might seem safe during a market freefall, holding too much cash long-term can erode purchasing power due to inflation.
• Cash has no volatility, but the gradual erosion of purchasing power due to inflation can be dangerous.
• Example: Investing in global stocks for 10 years would have yielded 60% higher returns than holding cash, even with a 5% yield.
• Deposit rates are declining, and interest from cash may not outstrip inflation.
• A diversified portfolio with cash as a component is recommended.

Don't Try to Time the Market

• Missing even a few of the best market days can significantly reduce portfolio value.
• Example: An initial investment of $10,000 would have grown sixfold if fully invested. Missing the 10 best days would result in a 50% loss, and missing 60 best days would result in a 90% loss.
• Time in the market is more important than timing the market.

Avoid Anchoring Bias

• Anchoring bias is basing investment decisions on initial information or entry price, even when market conditions or company fundamentals change.
• Investors are often reluctant to sell investments below their entry price.
• It's crucial to constantly review the investment thesis and understand whether a selloff is driven by sentiment or fundamental changes.
• Research is essential for informed decision-making.

What to Do During a Stock Market Plunge

Look for Bargains

• Market volatility can present opportunities to pick up bargains.
• Investors should look beyond short-term noise and focus on long-term fundamentals.
• The analogy of not selling a house due to short-term price corrections is used to emphasize a long-term investment view.
• Investors should carefully consider the price equation, including revenue, profit, and their relation to price.

Diversify Your Portfolio

• Diversifying into lower-risk assets like bonds or gold during market downturns is sensible.
• However, it's important not to ignore opportunities in the equity markets.
• This is a time to hunt for quality companies trading below their intrinsic value.
• Equities are crucial for higher potential returns, but require taking on additional risk.

US Tariffs and Global Trade

• The US share of global trade is 11%.
• Two-thirds of the world's countries trade more with China than the US.
• The impact of US tariffs might be smaller now compared to 20-30 years ago due to increased trade integration between non-US countries.
• Investors should focus on companies with strong balance sheets that can weather challenges.
• Avoid speculating on short-term outcomes and focus on medium-term investments.

Conclusion

During a stock market plunge, it's crucial to avoid emotional reactions like panic selling and instead focus on long-term investment strategies. This includes conducting thorough research to identify bargain stocks, diversifying your portfolio, and avoiding common cognitive biases like anchoring. While market volatility can be unsettling, it also presents opportunities for informed investors to improve their long-term financial outcomes.