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 very easy for it to always be in your face. The problem with taking in so much stock market hype is that it can cause you to make short-term decisions that go against your long-term best interest, and that’s never a good thing.
It can be more expensive than you think
A common mistake people make is to panic when share prices start to fall during bear markets and sell their shares prematurely – to cut their “losses” early or take a profit 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. If the price rises to $120, this drop to $80 becomes irrelevant.
If you’re panic selling to hurry up and lock in your profits before prices drop further, the one thing you don’t want to do is forget Uncle Sam because he definitely won’t forget you. Selling the stock for a profit will trigger a tax bill. If you have held the stock for less than a year, it will be taxed at your income tax rate. If you hold it for a year or more, it would be taxed at a more favorable capital gains rate. Here are the capital gains rates for 2022:
| Capital gains rate | Annual income (single) | Annual income (married, filing jointly) | Annual income (married, filed 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 |
Data source: IRS.
Depending on how much you earn in capital gains, you may find that your tax bill is more expensive than you realize.
For example, imagine if you bought 100 shares Netflix (NFLX -0.88%) in 2017 when the stock price was $170 ($17,000). In October 2021, the stock price was above $690, but has since fallen over 65%. If you saw the price drop and sold your 100 shares at $500 per share, you would have made $33,000 in capital gains ($50,000-$17,000). Assuming you’re in the 15% capital gains bracket, that’s $4,950 owed in taxes.
Think about future value
A short-term decision like panic selling can not only have current consequences (like a potential tax bill), but can also remove future value. Any stock you sell now is stock that you are not allowing to grow. Let’s get it American Express (AMEX) (AXP -0.23%), for example. In February 2020, AMEX’s share price had reached just over $135. However, from February 14, 2020 to March 20, 2020, the stock price dropped to just over $74.
Suppose someone owned 100 shares of AMEX, saw prices falling rapidly, and decided to sell their shares at $100 per share ($10,000). The same shares would be worth over $16,000 as of August 22nd.
This is not to say that selling stocks is inherently bad, because it is not. Sometimes it really is the best option. But part of being a long-term investor is understanding that ups and downs in the stock market are inevitable. Once you fully understand this, you’ll begin to see periods as opportunities to double down rather than avoid. Instead of selling your stocks, you’ll be looking to find great stocks at lower prices.
You can be very sure
Making controversial short-term decisions is not reserved for low periods in the stock market or for selling stocks prematurely; it can also come from overconfidence during bull markets when stock prices are rising. It’s not always easy to convince someone to invest when stock prices fall because they think they can wait and get the same stock cheaper. However, when stock prices rise, people rush to throw 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 depart from conventional investment wisdom — sometimes without even realizing it — because even flawed businesses manage to produce good returns. It is done more for speculation than cURRENT investment, which rarely ends well. You don’t want to buy stocks 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.