A brief dive into investor psychology, how stock market downturns can affect our ability to make rational decisions, and the opportunities and dangers that can arise.
For most of us, investing is a necessary part of life, whether we know it or not. Many of us prefer a hands-off approach, relying solely on performance in our professionally managed pension funds for later on in life, blissfully unaware of what is happening behind the scenes. For many others, a more hands-on approach has greater appeal and those taking a more active stance will often find themselves monitoring their portfolios and the global market developments with an eagle eye.
But this can be a costly mistake.
Humans are emotional creatures. Even for the most seasoned investors, we can often let our emotions cloud our better judgement. But when investing, we should never give into our fear and anxiety.
When investors see that their portfolios have suffered a sharp drop in a short amount of time, they can start to think and behave irrationally. They begin to think to themselves, “How much lower will this go?”, “Should I sell now to avoid further losses?”, “Perhaps I should sell now and buy back into the market when it bottoms out!”.
This is dangerous, not only because we enter the unpredictable realm of market timing and guessing market movements, but because it sets a bad precedent for our own approach to long-term investing.
But how can we mitigate this?
There are some simple, yet effective tactics which you can adopt to avoid this scenario:
- Checking your portfolios less – The more we check, the more we expose ourselves to portfolio movements and the more emotionally affected we are by temporary losses (and they’re always temporary).
- Tuning out the noise – It is easy to give into the fearmongering and market chatter coming from all angles, especially with the internet constantly at our fingertips. Stay away from online market chatter.
- Sticking to your long-term plan – Timing the market does not form part of any successful tried and tested methods of long-term investing.
- Buy and hold! – When we see that the markets, and therefore our portfolios, are up, we want to buy more. When we see that they are down, we want to sell. This just does not make sense; we should be accumulating in all market conditions.
A saying circulates in the investment world: “fortunes are made in recessions” and it holds a lot of truth. Stock market downturns provide fantastic buying opportunities. When markets are lower, then your future upside potential increases dramatically.
You should be accumulating and investing while asset prices are temporarily deeply discounted, as this will put your portfolio in the best possible position for growth when the market eventually turns. (And it always turns, eventually)
Let us look back at the S&P500 – the most followed index in the world. It collapsed by over 50% in the 2007/08 recession. If you had bought into the market crash at some of the lower points, you would have over 350% returns today – and this does not even account for all of the reinvested dividends.
It’s also important to remember that a lot of companies do not fundamentally change when the markets falls and selling out during a crash will cost us in missed dividends. Apple are still selling iPhone and iPads today, despite the lower share price.
You should also keep in mind that some of the biggest daily market gains come soon after the biggest daily losses and missing out on these days can be a regrettable mistake. If you sell out of the market and miss some of the biggest daily gains, your theoretical returns are enormously affected. Various studies have shown that missing out just the 10 best trading days over the past 15 years would have reduced your returns by 50%!
One of the all-time greatest investors, Warren Buffet, has been championing the saying “time in the market beats timing the market” for his entire career. This holds true. On average, a bear market lasts for around 9 months and most stock market crashes have been around 30%.
There has never been a time when the global market has crashed and never recovered. Should this ever happen, we will almost certainly have bigger things to be worrying about!