How to avoid the top 5 mistakes investors make in a market sell-off

Morgan Stanley Wealth Management


Summary: Learn how to spot—and potentially avoid—common mistakes that some investors make in a market sell-off.

There’s no doubt about it: market sell-offs are unsettling. Seeing your account value decline can cause even level-headed investors to second guess their strategy. The fact is that periods of volatility are not uncommon.

During these times, it’s important to recognize common investing mistakes—and know what to do instead.

1. Panic selling

It can be gut-wrenching to see your investment portfolio or the 401(k) plan that you’ve been building for years take a sudden dive. The urge to cut your losses and wait for the dust to settle can be overwhelming. Ironically, this can be the single most damaging thing an investor can do.

Selling into a falling market ensures that you lock in your losses. If you wait years to get back in, it can be hard to fully recover.

  • Instead, try this: Take the long view. If you don’t need cash right away and have a well-diversified portfolio, realize that downturns ultimately tend to be temporary. The market may sometimes feel like it could go to zero, but history has shown that rebounds can return many portfolios to the black in due time.1

2. Moving to cash and staying there

This mistake compounds the damage from panic selling. The strong rebound in stock prices that often follows a market downturn should underscore how bailing out can cost you when the market reverses direction. Take, for example, the 2020 pandemic-induced market downturn. The strong rebound in stock prices just weeks after their March lows is a good example of how bailing out can cost investors when the market reverses direction and they are still sitting in cash.1

  • Instead, try this: Investors who have more cash than their long-term strategy calls for because they sold during the market slide, or for any other reason, may want to look to close that gap and get invested. Dollar-cost averaging, a method of automatically investing the same amount at regular intervals (say, monthly) to get back into the market gradually, can be a good way to get there.

Dollar-cost averaging potentially reduces the sensitivity of your portfolio. This can make it easier for anxious investors to avoid the worry of putting a big chunk of money into the market, only to have the sell-off resume. If the market rebounds, they will be glad that they already put some of their money back to work, rather than having all of it on the sidelines.

S&P 500: 1/1/20–6/30/20

Chart displaying S&P 500 data from January 1, 2020 to June 30, 2020.

Source: FactSet Research Systems. Past performance is no guarantee of future results. An investment cannot be made directly in a market index.

3. Not recognizing your own strengths and weaknesses

Many people tend to overestimate their ability to judge when an investment is a great deal at a certain price. They might compare the price of a stock that’s been beaten down consider it an opportune time to buy.

But stocks that undergo wrenching losses often do so for fundamental reasons, and the possibility they still have further to fall is considerable. This practice of buying into a down-trending market and profiting from short-term trading is a lot more difficult in practice than it seems.

  • Instead, try this: Know that, in times of market uncertainty, you don’t have to go it alone. E*TRADE from Morgan Stanley has educational resources plus thought leadership and commentary on the latest market happenings. Or consider talking to a professional who can help you understand how to proceed, based on your time horizon and risk tolerance.

4. Holding on to losers

Most people don’t like selling investments at a loss. This can cause them to hang onto losers too long believing those stocks will rise again, and to sell winners too early worrying those stocks will decline. Often, investors would be better off selling stocks doing poorly in the market and holding onto stocks that are rising because they are better positioned for the current environment.

  • Instead, try this: Consider tax-loss harvesting. If losses arise in a taxable investment account, “harvesting” them by selling those positions can improve long-term tax efficiency. Also, some investors may be better off converting at least some of their retirement savings from a Traditional IRA to a Roth IRA if eligible. Since there are tax consequences, doing a conversion when stock values are depressed may potentially increase tax benefits over the long-term.

Most people don’t like selling investments at a loss. This can cause them to hang onto losers too long believing those stocks will rise again, and to sell winners too early worrying those stocks will decline.

5. Forgetting to rebalance

During a major market decline, a portfolio’s asset allocation to equities tends to decrease substantially, as stocks sell off and bonds rally. Forgetting to rebalance back into equities may extend the amount of time a portfolio takes to recover from a market downturn.

  • Instead, try this: If you’ve decided on a rebalancing plan, stick to it. Some studies have shown that rebalancing tends to improve risk-adjusted returns over time (as long as it doesn’t generate excessive tax and transaction costs) by reducing portfolio sensitivity to the timing of up and down markets.1

Tools like E*TRADE’s Portfolio Analyzer (login required) can help investors take a deep dive into their asset allocation to make sure their portfolio is still mapped to their goals, risk tolerance, and time horizon.

Investment losses are painful. But if you can stay focused on your individual goals—rather than fixating on daily market noise—you may likely be better off in the long run.

1 Morgan Stanley Wealth Management Global Investment Office, December 2023.

The source of this Morgan Stanley article, Top 5 Mistakes Investors Make in a Market Sell-Off, was originally published on August 30, 2023.

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