There is a lot of noise in the stock market. You have daily price swings, quarterly earnings calls, speculation, and a smartphone that makes it all too easy to be in your sight at all times. The problem with taking on so much of the noise in the stock market is that it can lead you to make short-term decisions that are against your best long-term interests, and that’s never a good thing.
It can be more expensive than you think
A common mistake people make is to panic when stock prices start to fall during bear markets and sell their stocks prematurely – to cut their “losses” early or take profits while they can. The thing about losses in your portfolio is that they are unrealized losses, meaning they only exist on paper. If you buy a stock for $100 and the price drops to $80, you’ve only lost $20 if you sell it. If the price rises to $120, that drop to $80 becomes irrelevant.
If you’re panic selling to hurry up and lock in profits before prices drop even further, the one thing you don’t want to do is forget about Uncle Sam, because he definitely won’t forget about you. Selling shares for profit will trigger a tax bill. If you held the stock for less than a year, it will be taxed on your income. If you hold it for a year or more, it will be taxed at a more favorable capital gains rate. Here are the capital gains rates for 2022:
|Capital Gains Ratio||Annual income (single)||Annual income (married filing jointly)||Annual Income (married, filing separately)|
|0%||$0 to $41,675||$0 to $83,350||$0 to $41,675|
|15%||$41,676 to $459,760||$83,351 to $517,200||$41,676 to $258,600|
|20%||$459,761 or more||$517,201 or more||$258,601 or more|
Depending on how much you make from capital gains, you may find that the tax bill is more expensive than you realize.
For example, imagine you bought 100 shares of Netflix (NFLX -0.88%) in 2017 when the stock price was $170 ($17,000). In October 2021, the stock price was above $690, but since then it has fallen by more than 65%. If you saw the price drop and sold your 100 shares at $500 per share, you would make $33,000 in capital gains ($50,000 – $17,000). Assuming you’re in the 15% capital gains bracket, that’s $4,950 in taxes owed.
Think about the future value
A short-term decision like panic selling can not only have present consequences (such as a potential tax bill), but can also reduce future value. Any stocks you’re selling right now are stocks you’re not giving a chance to grow. Let’s take American Express (Amex) (AXP -0.23%), for example. In February 2020, the AMEX stock price reached just over $135. However, from February 14, 2020 to March 20, 2020, the stock price fell to just over $74.
Let’s say someone owns 100 shares of AMEX, sees the price drop rapidly, and decides to sell his stake at $100 per share ($10,000). Those same shares will be worth over $16,000 as of August 22nd.
That’s not to say that selling stocks is inherently bad, because it’s not. Sometimes it really is the best option. But part of being a long-term investor is understanding that the ups and downs of the stock market are inevitable. Once you can fully understand this, you’ll begin to see down periods as opportunities to double down instead of avoiding. Instead of selling your stocks, you’ll be looking to find great stocks at lower prices.
You may be overconfident
Making questionable short-term decisions is not reserved for periods of stock market decline or premature stock selling; it can also come from overconfidence during bull markets when stock prices rise. It’s not always easy to convince someone to invest when stock prices are falling because they think they can just wait and get the same stock cheaper. However, when stock prices rise, people rush to put money into the stock market to take advantage of the gains.
“Everyone is a genius in a bull market” is the harsh truth. During bull markets, many investors deviate from conventional investment wisdom – sometimes without even realizing it – because even the wrong businesses manage to generate good returns. It becomes more about speculation than actual an investment that rarely ends well. You don’t want to buy a stock because you believe the price will produce X% returns in X years; you want to buy them because you believe in the companies and their long-term potential.
American Express is an advertising partner of The Ascent, a Motley Fool company. Stefon Walters has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Netflix. The Motley Fool has a disclosure policy.