It has been said that retail investors, if left to their own devices will often behave in the opposite direction they should.
There is a discipline in behavioral finance whose theory is built around the concept that the typical investor acting without advice will indeed head in the wrong direction the majority of the time. The theory suggests that if you do the opposite of what the masses are inclined to do, you will most likely be heading in the right direction.
I remember chuckling when I first learned of this concept but it’s a legitimate theory based on the analysis of investor behavior with some interesting statistics behind it. What causes this phenomenon? Emotion. Fear.
Notorious investment mogul Warren Buffet has been famously quoted as saying, ‘Be fearful when others are greedy, and greedy when others are fearful’.
2018 was a challenging year for market returns and global economic growth which shook investor confidence significantly. The fourth quarter of 2018 saw sharp declines.
This kind of market drop wreaks havoc with the investors psyche.
The fact that this happened largely in the month of December when year-end investment statements are due certainly compounds investor stress.
Someone once said the stock market is the only store where consumers rush out of when things go on sale and rush to purchase when the prices rise.
So far in 2019 we’ve already seen some bounce back from these December lows as is often the case. The investor who stayed invested has benefited so far this year. Market drops are only losses on paper. They are not realized until the moment you sell. The key is resisting the urge to sell.
When markets drop, investors become scared and the automatic emotional reaction is to get out. But doing so may in fact result in selling at a low. In theory, your strategy is to buy low and sell high after attaining growth but in practice investor nerves can get in the way. Especially when fear is at play.
Most investors say they can handle market volatility but many struggle. In times of market downturns investment advisors have their work cut out for them to keep investors off the ledge. Advisors work to remind their clients of their long term goals, keep an eye on economic and market trends and updates and tweak when and as needed. But what happens when you are an investor who doesn’t’ have that support or guidance?
This week, we participated in a 2019 Capital Market Economic Update conference call and the expert speaker indicated that December 2018 had the largest sell off of balanced and equity funds among retail investors since the credit crisis of 2008. He summarized this by saying; ‘…once again this re-affirms the fact that retail investors repeatedly sell at the bottom.’ These investors might have felt a small satisfaction in taking a flight to safety in December but as a result of exiting the market might have missed a significant portion of the initial rebound.
Jill Schlesinger, Business Analyst at CBS News captured this investor sentiment quite well. An excerpt from her post reads:
“Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions, when to sell and then when to buy back in, something that is nearly impossible. The data show that when investors react, they generally make the wrong decision, which explains why the average investor has earned half of what they would have earned by buying and holding an S&P index fund.
The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you’re a long-term investor, who doesn’t have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon –one that is not reactive to short-term market conditions, because over the long term, it works. It’s not easy to do, but sometimes the best action is NO ACTION.”
How do you stay the course during challenging markets?
- Make sure you understand your own risk tolerance
- Make sure your investments match your risk tolerance and long term goals
- Understand that volatility is the very nature of the market
- Understand that you can use volatility to your advantage
- Invest in high quality, well managed investments rather than something risky if not suitable
- Choose a financial advisor who you trust to look out for your best interests and be the voice of reason when you need it most
Investors need to keep a level head during these times, so they can stay the course during these challenging markets.
This column appears in This Month in Elgin February 2019 edition.
Stephanie Farrow, B.A., CFP., Stephanie has over 25 years’ experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and Certified Financial Planner designation. Stephanie has been writing a financial column for local business magazine Elgin This Month/This Month in Elgin since 2010. Stephanie and her husband Ken Farrow own Farrow Financial Services Inc. About our Farrow Financial Team.