Why selling in a market downturn isn’t a good idea

Q. I hear the biggest mistake is to sell when the market is falling. How is that different from rebalancing a portfolio?
— Out of balance

A. You’re right that the biggest mistake most investors make is to sell when markets are falling.

Markets act in cycles and surely what sectors go down will in time go up, said Debra Morrisson, a certified financial planner with Empowered Retirement in Lincoln Park. She said the two important questions are: when will they recover, and how rapidly will they recover.

Because investors who sell when the markets fall are often panicked, they often need “proof” of when it will be “safe” again to buy back in, Morrison said.

“Sadly, that ‘proof’ is hard to measure and quite subjective, hence investors tend to remain on the sidelines, missing the very recovery of the price drop they suffered in fleeing the market in the first place,” she said. “Market recoveries can occur in the space of one to two days; it’s virtually impossible to calculate or forecast, despite what the media pundits purport.”

Rebalancing, on the other hand, involves assessing your portfolio to detect differences from your original asset allocation and trading to reset to that original desired percentage.

Morrison offered this example: If the probability was highest that you would achieve your goals given your timeline and current assets by being invested 60 percent stocks and 40 percent bonds, and because of market performance, your portfolio is comprised instead of 70 percent stocks and 30 percent bonds, you would sell the excess 10 percent in stocks (‘temporary winners’) and buy bonds (‘temporary losers’).

Rebalancing is, however, almost impossible for the average investor to implement because it goes against our mental grain of selling our ‘temporary winners,’ she said.

“I use quotes around ‘temporary winner’ and ‘loser’ because indeed each asset class rotates between the extremes,” she said. “Investors simply need to be patient for our temporary losers to win again so that we can rebalance our portfolio and achieve our goals.”