A hope for a better future for ourselves and family. Our retirement. Our financial security. Our investments.
Economic and political uncertainty. Headlines. Twitter. CNBC.
Market volatility.
When people dwell upon any of these things, it can guide them to one place. Fear.
The fear of loss, or the desire to avoid losses, is clearly a powerful motivator in investing. Experts in behavioral finance recognize that people experience gains and losses disproportionately. In fact, it is believed that investors feel the pain of losses twice as much as they experience the pleasure of gains1. But does this lead us to rational decision-making when a market is volatile or in a correction?
The urge to get out of the volatile markets until things become less unpredictable is understandable. It may help the individual to rest easy, knowing that as markets gyrate, it isn’t hurting them. And, at the end of the day, making sure our investments aren’t causing us to lose too much sleep might be a functional approach. But, in the long run, is it likely to help our objective of growing our assets toward our future goals? Unfortunately, the answer is that it typically isn’t.
As markets enter a phase of negative volatility, most investors remain cautiously optimistic. Small losses from previous gains are typically easy to absorb and don’t lead to too much discomfort. But, if the period of negative volatility extends on and losses build, so too do the negative emotions associated with those losses. This is when inexperienced investors often go astray. As prices drop, many investors become less content with their holdings and more likely to sell out. If the situation reaches a point of capitulation, and investors liquidate, the likelihood of them going back into the market at better prices is usually slim. One famous investor, Nathan Rothschild, is credited with the saying “the time to buy is when there’s blood in the streets.” Unfortunately, individual investors are far more likely to sell than to buy in this scenario.
The most compelling factor that drives successful investing is the ability to withstand short-term volatility and allow time to reduce your risk of selling at a low.
A case in point occurred in 2008 in the midst of the most significant financial crises of our lives. Warren Buffet, the famed “Oracle of Omaha,” made a $5 billion investment in Goldman Sachs at a time when many investors thought the financial world was crumbling. What would lead a person to take on such a seemingly outrageous risk? Well, as he has explained on numerous occasions, the risk of buying when prices are low is usually less than the risk of investing when prices are high. Smart investors look for opportunities to deploy cash into attractively valued securities in volatile markets. Oftentimes, this is when less insightful investors are selling out of fear.
Another unfortunate lesson of the financial crisis was that fear stays with us even after things have improved. Some of our clients still cite the market swoon of 2008 as a cause for anxiety. Sadly, many individual investors did not get back into the markets in time to recoup losses sustained in 2008 and early 2009. As late as 2015, it was being reported that a high percentage of individual investors had not fully re-invested their portfolios, and therefore had not fully recovered their losses. This was at a time when the S&P 500 had recovered to the tune of approximately 160% from its low2.
Markets go up and down, sometimes in large swings, as we’ve seen in recent years. However, the bias of markets has always remained upward. Consequently, for investors who are willing to ride out volatility and not lock in relative losses, they may benefit from the upward bias over the long run. In most cases, investing is about tilting the odds in your own favor. The most compelling factor that drives successful investing is the ability to withstand short-term volatility and allow time to reduce your risk of selling at a low.
As we look forward, we are confident in the strength of the U.S. economy to continue its expansion for the foreseeable future. While geo-political events never seem to be a positive factor for markets, we think that insightful investors will ultimately sift through the noise and discover areas of opportunity. We’re working hard with our research partners to identify and capitalize on those opportunities, as well as protect portfolios from the negative effects of volatility.
As always, if you have any questions about this or any other financial topic, please feel free to contact your Atlas Wealth Management Advisor.
1 BehavioralEconomics.com, Behavioral Science Concepts, Loss aversion
2 Finance.yahoo.com – S&P 500 (^GSPC) April 1, 2009 – July 1, 2015
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