Just about everyone will lose money when the stock market takes a dip. Whether that loss is temporary or permanent depends on the investing moves you make both before the crash and during it. The following three mistakes could decimate your portfolio and put your finances in serious jeopardy, so you should avoid them at all costs.
1. Not diversifying enough
Diversifying your portfolio is one of the most important things you can do to protect yourself against loss. By investing in many securities, you ensure that no single one has too great an effect on your portfolio. When one stock price drops, you'll have others to pick up the slack.
It's not quite as simple as investing in multiple stocks, though. You also need to make sure you have your money spread around in many sectors, so that if one is hit hard (as was the case with a lot of tourism-related businesses during the COVID-19 pandemic), you won't lose everything. You should have some of your money in bonds and other safe investments as well to balance out the stocks you own.
One of the simplest ways to diversify your portfolio quickly is to invest in an index fund. These are collections of stocks that track a market index, like the S&P 500 or the Dow Jones Industrial Average (DJIA). They often contain hundreds of stocks in several industries, and they generate returns that are very similar to their underlying index. Their fees are pretty affordable too. Some of the most popular S&P 500 index funds have expense ratios of just 0.03%. That means you only pay $3 per year if you have $10,000 invested.
2. Emotional buying and selling
Hearing a lot of chatter about a stock on social media can make some inexperienced investors tempted to buy a lot of it in the hopes of becoming an overnight millionaire. And seeing a stock in their portfolio plummet can make some want to sell for fear of losing even more if they hold onto the stock.
But it's often best to avoid these rash moves. If you guess wrong, you could waste your money on a stock going nowhere or turn a temporary loss into a permanent one by selling too soon. Instead, do your research into an investment before buying or selling. Focus on its long-term growth potential. Don't worry about day-to-day shifts unless you begin to notice a larger trend that suggests the company may be heading for trouble.
3. Investing money you'll need in the next few years
Keep money you plan to spend in the next five to seven years out of the stock market if you can. Investing is one of the best ways to grow your wealth over the long term, but the stock market's volatility makes it a bad place for short-term investments. If you need your money at a certain time, you have to sell, regardless of what your shares are worth at the time. That could mean taking a huge loss.
If you'd rather not leave your money in a savings account earning next to no interest, try stashing it in a high-yield savings account or a certificate of deposit (CD) instead. These won't give you the same returns that investing your money could, but there's no risk of loss. Plus, savings accounts enable you to withdraw your funds at any time. CDs typically don't allow you to withdraw money before the CD term is up, or else you'll pay a penalty. But that shouldn't be an issue if you know you won't need your money for a while.
The underlying thread in all three of the mistakes above is not thinking about how your decisions could affect your finances down the road. Even when times are good, you should always be thinking about how your portfolio will fare in a market crash, because you never know when the next one's going to happen.