Five traps that come with unpredictable markets

When markets are turbulent, our investments can become unstuck if we fall into one or more of the five traps described below.

1. We let our emotions take charge

One of the characteristics of the stock market is that in the short-term, it can be driven as much by sentiment, i.e. how people feel, as it is by the financial prospects of the companies that make up the market. Emotions are particularly apparent at market peaks and troughs when confidence is highest and at rock bottom respectively.

Conventional wisdom says 'buy low, sell high'. This means that you purchase investments when prices are cheap, i.e. good value, and sell when the prices go up so you make a profit. Most people can understand this principle easily when it comes to buying and selling property.

But when it comes to investing in the stock market, emotions can run so high that many people behave in exactly the opposite way. For example, it would be like you wanting to put your house on the market as a result of finding out that its value has just fallen significantly. Doesn't make sense, does it?

2. We sell when markets fall

The results of a fearful approach to investing can be very damaging. One of the worst consequences is to sell investments that have fallen in value because you panic or are afraid of them falling further in value.

History shows that stock markets have recovered from steep falls, which should give us confidence that paper losses are likely to be recouped. But remember that past performance is not a reliable indicator of future results. Once you're out of the market, real losses are much harder to regain if you are no longer invested and need to find other ways to make up your losses.

Remember that when the value of your investment falls, you only lose money if you sell it. Be wary of turning 'paper losses' into real losses.

3. We forget why we invested in the first place

Getting caught up in the fear and panic that arises when markets are turbulent means that we can lose sight of the long-term commitment we entered into when we first made the investment.

Part of this commitment involves not being swayed by short-term fluctuations, crises, 'bubbles' bursting and other events. These are not trivial by any means, but they are not necessarily reasons to change your view about what you want to achieve with your investments.Ups and downs, minor as well as dramatic ones, will always feature in the cycles of the stock market.

We believe that reacting to these short-term events means that you will miss out on the long-term rewards that come with patience.

4. We miss out on opportunities when markets recover

History tells us two further things about stock markets:

- They turn and rebound quickly before the signs become clear in the economy, and
- Most people, even the experts, can't 'time the market' and work out the best time to buy investments to take  advantage of market recoveries.

If you sell your investments with a view to purchasing again when the markets rebound, you may be taking a big gamble. Markets tend to bounce back very quickly and you may be better off staying put instead.

5. We become over-cautious

Safe havens, like cash savings, can feel attractive when markets are turbulent. The 'flight to safety' is understandable, but we would urge a word of caution. Cash savings have an important role to play to meet day-to-day living costs, for short-term savings (e.g. holidays) and as an emergency fund (e.g. for unplanned expenses).

However, when it comes to putting money away for the long-term, cash is usually not the best option for two reasons. Firstly, while past performance is not a reliable indicator of future results, history shows that stocks and shares tend to perform better than cash over the long-term.

Secondly, putting money into cash that you want to grow over five years or more exposes your money to the effects of tax and inflation that erode your returns. Because the stock market has the potential to grow more than cash over the long-term, you are more likely to offset the effects of tax and inflation with stock market investments. Furthermore, with interest rates likely to fall further, the 'buying power' of cash savings which is put away over the long-term may diminish further.

How to avoid these traps

Firstly, if you are unsure about your investments, get financial advice. A good adviser will act as a useful sounding board for you, and help you to understand the risks and rewards you can expect over a period of time.

Along the way, all you may need is reassurance every now and again. Your adviser can help you to check that you are still on the right track and help you make adjustments if your goals or needs change.

Most importantly, in turbulent times, your adviser can help you to avoid panicking and making decisions that you will regret in the future. Remember that often, doing nothing may be the best course of action.

Secondly, to understand how you can make the most of the money you want to invest, follow our six keys to long term investing.