The emotion of fear is good when it prevents harm (fight or flight).
On the other hand, fear can be bad when it comes to many other “should I or shouldn’t I” decisions.
In the context of investments, individual investor returns are almost always worse than market returns. Fear and greed are the major culprits causing that. Think back to the 1st quarter of 2020. By March of that year the stock market (Russell 2000 Index) was down 30%. Fear was rampant and investors were “selling low”. Yet by December, when the stock market was up by 18% for the year, most of those sellers had not yet bought back into the market as the news was still bad, and the future was uncertain. When they did feel it was safe to get back in, they wound up “buying high”. It’s tough to make money with that approach.
To make money investing, you need to buy low and sell high. The only time you get to buy low is when the news is bad. It’s counterintuitive, but true. 2020 was not an isolated case of fear causing investors to sell low and then buying high when the news was finally good. Think of the Great Recession in 2008. The best time to buy stocks or real estate was early April 2009, however, the news at that time was far from good. How many people do you know who bought stocks or real estate in late 2008 to early 2009? Real estate and stock prices have moved a lot higher in the years since then.
Another reason investor returns are not better than market returns is they don’t have enough information on the history of markets. Can you remember what two U.S. stock market records were broken in 2020? One was the largest decline in the shortest time – ever. The second was the largest increase in the shortest period of time – ever. Did 2008 and 2020 teach you anything about the behavior of the U.S. stock market? Spanish philosopher George Santayana said, “Those who cannot remember the past are condemned to repeat it.”
Consider some life situations requiring decision-making –
- You go to doctors to find out what is best for you. They have the knowledge and experience to advise you.
- Your CPA can help you get through the 3 million words in the Internal Revenue Code and the 9 million words in the IRS regulations that detail how the 3 million words are to be put into effect.
- Your estate planning attorney helps you get your affairs in order. He/She provides counsel based on expert knowledge about living trusts, charitable remainder trusts, deceased spouse’s unused exemption, etc.
- Your investment advisor makes recommendations for your financial future based on 20, 30 or more years of experience and good analytical tools based on historical data.
Are you accepting advice from these experienced professionals you are paying to keep you on the right track? Or are your decisions being driven by your current emotions which quite likely are influenced by the latest headlines?
Whether we like it or not, emotions do impact our personal decisions. When it comes to decisions for investing, experienced professionals use events of the past to inform a rational, analytical approach to current investing strategy. You are wise to lean on them to avoid emotional decisions with potentially costly outcomes.
Phillip Cook CFP® is Principal of Mogul Wealth Management in Manhattan Beach. He is a member of Torrance Memorial’s Professional Advisory Council. firstname.lastname@example.org, (310) 545-6700