Imagine you’re at the stage where you finally have a decent amount of money to invest. After a painstaking amount of research you carefully construct a portfolio of low-cost ETFs with broad exposure to global markets, plus a healthy dose of bonds to smooth out the ride. You determine your rebalancing threshold and then set-up automatic contributions to your account each month. Then, three months later, when you check on your portfolio you’re shocked to discover it’s down 2 percent. How did that happen?
It’s common for newbie investors to get skittish when the stock market suffers a setback – even a seemingly small one. Investing is a long-term game but there can be wild rides along the way and it’s not unusual for a portfolio to lose 20-40 percent of its value during a bear market.
Coping With Stock Market Losses
Coping with stock market losses is part of the investor experience and something that for new investors can be difficult to stomach. That’s especially true when you consider the spectacular bull market we’ve seen since coming out of the financial crisis in 2009.
In a recent episode of the Canadian Couch Potato podcast, Dan Bortolotti shared a question from an online forum called Reddit Personal Finance Canada. This particular investor set up a portfolio based on one of the couch potato model portfolios with 90 percent equities and 10 percent bonds. In just six months the portfolio was down 1.94 percent and this investor wanted to know if he or she did something wrong and should abandon ship.
Dan tactfully answered the question without picking too much on the newbie investor, however this type of question is asked almost daily in forums like Reddit and it’s a concerning trend for new do-it-yourself investors. Here’s a question posed recently about TD’s e-Series funds:
“Five months ago I finally did the e-Series thing with TD and I followed the Couch Potato formula. Right now I have an RESP and a young child so I put it at ‘Assertive’ since I can leave it there for awhile. I keep checking it and I am down money as of now if I don’t count the gov’t grant. Is this normal? I am not used to this type of investing and need to reassure my nerves.”
Smart young investors have bought into the idea that low cost passive investing will lead to better outcomes than using more expensive actively managed mutual funds. They read blogs and online forums, listen to the Canadian Couch Potato podcast, and are determined not to make the same investing mistakes that their parents made or that the masses make every day.
After all that research they select a well-balanced, low-cost portfolio of ETFs or index mutual funds, confident their investment choices will outperform 80-90 percent of investors, just like the research says.
These new investors do everything right except for two things:
- They can’t stop checking on their portfolio in an attempt to validate their choices.
- They don’t compare their returns with an appropriate benchmark.
The fact is, even a perfectly constructed portfolio (is there such a thing?) can lose money in a number of ways. Anyone of the Canadian, U.S., or International markets could be down at any given time. The loonie increased by 10 percent this year, which negatively affects international equities when they’re converted back to Canadian dollars.
Then there’s the phenomenon called fear of missing out, or FOMO. New investors are constantly comparing their strategy to others who fill their ears with bullish news about Bitcoin, Tesla, or the latest medical marijuana stock. Meanwhile index funds just chug along, delivering market returns, but likely not the type of double-or-triple-digit returns you might see from a hot story stock. There’s always temptation to stray or change strategies.
If new investors are shaken by a 2 percent stock market loss over six months, imagine how they’ll react to a true market meltdown?
My advice is to keep your portfolio as simple as possible, stick to a rules-based approach to rebalancing and contributing new money, ignore other investors who talk-up different strategies (or talk-down to yours), and for crying out loud quit checking on your portfolio every day!