Keep Calm and Carry On: Investor Psychology in a Turbulent Market
I’m the kind of person who enjoys checking the market every day, and at least a few times throughout the day. With my phone at my side, it’s easier than ever to keep abreast of current economic developments. As I write this today, the S&P 500 is down 1.85%, the NASDAQ is down 2.5%, and the Dow is down 1.4%. Not a great way to start 2022, particularly following last week’s bloodbath. Impulsively, I feel like I need to be doing something to protect my holdings. What should I do to immediately safeguard my assets and stave off further losses?
It is remarkable how much human psychology relates to investment and finances. As humans, we are wired to spring into action at the slightest sense of impending personal harm, danger, or loss. If a plane is going down, anyone’s first inclination would be to take hasty action to call loved ones, put on oxygen masks, locate the nearest exit, and brace for impact. There’s a reason we ever invented parachutes! The same can be said for investor psychology. When we see red on a chart, we have a nearly Pavlovian response to exit our holdings or current strategy. The inverse is true as well. Green on the chart inherently makes me feel a certain sense of financial security and success. There is a good side to this fight-or-flight, adrenaline-filled behavior we exhibit. It helps us to identify risk, take action, and protect ourselves. However, in the world of investing, it is far riskier and more dangerous to quickly act when there are adverse market conditions.
Source: trademetria
A great example of this is Black Thursday, October 29, 1929, when the Dow Jones Industrial Average lost an astonishing 12% in a single day. Perhaps the largest contributing factor to this dramatic downturn that kicked off the Great Depression was investors’ panic and subsequent sell-off of securities. It is hard to say that anyone would not have been tempted to act and respond to the panic in the way investors of 1929 did on Wall Street. However, a great lesson we can learn from that day and others in history (such as Black Monday of 1987) is that panic and hasty decisions do not lead to long-term financial success. It is perhaps the hardest and least natural decision to stay calm and carry on in such turbulence.
Perhaps one of the easiest ways to combat our propensity to panic is to zoom out from the daily ups and downs of the market and look at past market historical performance over longer periods of time. Let’s look at the S&P 500 historical charts from specific periods of time as of today:
Chart source: Google Finance
Based on today’s performance, you would not want to own the S&P 500, with a loss greater than 1.5% thus far since this morning. The last five days have not been any better, with an overall loss of 4.5%. Even zooming out to one month, you would be looking at a loss of 2.39%. It’s not until we look back six months that we see green, with a positive return of 4.87%. The further charts are also all positive, with a 21% return in the last year, 102% return in five years, and an astonishing 3,853% in the last 40 years since 1982. You don’t even have to look at the numbers to see what I’m getting at. If you simply look at the volatility of the line on the chart from today, the last five days, or one month, you can see a lot of sharp ups and downs. Even in the last six months, despite the overall positive return, the S&P 500 has not had a smooth ride by any means. But as you zoom out, you start to see a bigger picture. Smoother-looking returns over longer periods of time. The term “mean reversion” refers to the tendency of securities over time to revert to their long-term mean return. The S&P 500 has a Compound Annual Growth Rate (CAGR) of 10.6% from 1982 through the end of 2021. Over any small period of time you are going to find greater volatility and potentially large downturns. However, the long-term story of the U.S. stock market has been a steady upward progression over several decades.
Consider an analogy. Say you zoom in on a blade of grass with a powerful microscope. You are going to see a very complicated, cellular structure. Unless you are a botanist, you won’t be able to make heads or tails of what you are looking at. However, as you start to zoom out, you will be able to see that those cells make up a blade of grass, and that blade of grass is part of a huge field of grass, and that grass is part of a beautiful green, rolling landscape. If you focused on that single microscopic image, you would be missing that it is a minuscule part of something entirely different.
Images source: Pexels
The same is true of investing, and having a long-term, macro perspective has far-reaching implications for investors in a hot and cold market. Our human tendency is to focus on the here and now, the minutia, the seemingly large perils of short-term market volatility. It is in these moments that we must check our emotions at the door and follow some simple, prudent rules that will keep an investor grounded:
Don’t panic. Panic hardly ever ends in anything good for your portfolio. A calm, unalarmed mindset will help you to make more rational decisions when everyone else is freaking out.
Be patient. If you had told me on March 12, 2020 how well the market would perform over the following 18 months, I would never have believed you. The market was reeling from the growing COVID-19 threat and ensuing government and societal shutdowns. What followed was a huge market rally that took the market to heights unknown even before the pandemic. Those who rode it out were handsomely rewarded and ended up in a better long-term position than they started in. While this is anecdotal related to the pandemic recession, the market will generally recover at a more rapid rate following a rapid downturn in the economy.
Don’t do as others do. If you are a part of Reddit subgroups, follow financial gurus on social media, or simply look at the news headlines, you will see a wide variety of opinions and reactions to bad news and market volatility. Like a horse is given blinders to focus on the road ahead and not worry about the surrounding environment, it will serve you well to try as best as you can to drown out the noise around you. Fear and panic are loud, but a well-informed, experienced investor will learn to either ignore what other people are saying in panic, act cautiously on it, or take a contrarian stance and generally be rewarded for it. It’s great to follow or heed advice from other smarter or more experienced people, but always be extra cautious to take that advice with a grain of salt when the market is plummeting or soaring.
Stay the course. Whether you are a traditional buy-and-hold investor who has held one broad-market index fund for the last 30 years, a soon-to-be retiree with a conservative 60/40 stock-bonds portfolio, a quant investor who uses complex algorithms and tactical asset allocation, or a day-trader relying on short-term pricing changes, stick to your strategy! If you find over time that your long-term strategy is underperforming or no longer works, carefully and slowly consider changing long-term strategies. However, never make the decision to change your investment strategy in the midst of a panicked market sell-off. Human nature is to buy low and sell high, but in the midst of market turmoil the average investor will sell their assets on the way down to prevent further loss, and during booms will buy assets too late when prices are nearing their peak. I’m not trying to minimize the importance of picking a good investment strategy that fits your risk and investment profile (there are certainly plenty of terrible strategies out there), but choose a good time to make any changes to your strategy, and only after much research, thought, and time put into making this decision.
Well, there you have it. I hope by the time you read this article the market has improved a little bit, but if not, remember to keep calm and stick to your guns. It’s very hard, so don’t beat yourself up for wanting to act quickly. Just take a deep breath and remember you are in it for the long-haul. A single day will not make or break your financial future, but small, rash decisions can have drastic negative effects. I’ll end with a quote from the ever clever Mark Twain: “There are two times in a man's life when he should not speculate: when he can't afford it and when he can.” (Source: Goodreads)
Note: By then end of writing this article, the markets have nearly all but recouped their earliest losses today. Exhibit A on short-term market volatility!
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The opinions expressed in this article are solely the opinions and views of the author. None of the views expressed are to be misconstrued as professional advice or recommendations, but rather for entertainment and recreational enjoyment. Past performance is not and should not be used as an indicator of future performance.