With Paranormal Activity 3 setting records at the box office, it’s a good time to talk about how fear can impede sound investment decisions. Certainly, the acute market volatility we’ve experienced over the last few years has sparked a growing fear among investors of incurring additional losses. How does this attitude impact your portfolio? Interestingly, a Fidelity survey of participants in workplace retirement plans during the turbulent 18-month period from October 2008 to March 2010 quantifies just how much letting yourself fall into fear’s grips can hurt.
Fidelity found retirement investors who kept contributing to their plan and who maintained some exposure to equities throughout the period were better off throughout the market’s roller coaster ride than those who moved in and out of the market in an attempt to avoid losses. Specifically, the 81,400 who sold all stocks in 2008 had an average return of -6.8 percent over the period. On the other hand, the 7,332,000 who sat tight and kept investing in equities earned an average 21.8 percent over the 18 months.
We tend to retreat during market turbulence because, as behavioral finance pioneers Daniel Kahneman and Amos Tversky have shown, human beings have a stronger preference for avoiding losses than for registering gains.
Recognizing and adjusting for this innate bias may help prevent you from making fear-driven decisions during dark days in the market. Think about your own behavior during past downturns. Did you make any fearful decisions that you now regret? With volatility looking like it’s here to stay, has your risk tolerance changed? If so, it may be necessary to make adjustments to your portfolio. Otherwise, the best advice to keep short-term volatility from prompting emotional fear-based decisions that can negatively impact your portfolio is to stay focused on your long-term goals.
As Benjamin Graham, a pioneer in security analysis said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” As our clients’ trusted advisor, it’s our job to help minimize the impact of inescapable emotional swings and maintain disciplined investing.