Volatile markets often bring out the worst in investors. Some bail too soon, while others prefer to “wait it out in cash.” Yet another group refuses to invest in stocks at all. All of these investors are at risk of letting their emotions determine how they invest. They are frequently wrong, costing them gains that they could otherwise reap by doing nothing.
Thanks to the emerging field of behavioral economics, we can identify what investors consistently do wrong. How do we resist the temptation to exit the market at the first sign of trouble? The best route is through identification, education, and planning.
When you can identify what behavior is likely to occur under certain market conditions, you can take corrective (or better yet, preventive) action. Here are some antidotes to behavioral mistakes that often crop up in volatile markets:
Don’t Try to Time It. Nobody can tell you with any accuracy when a bull market will begin and end. It’s rarely a straight line, and any number of gremlins can trigger a downturn. But trying to time the end of a bull market often leaves investors worse off than staying fully invested.
How can that be? Most investors guess wrong when timing the market. According toFactSet Research Systems, if you were to miss the 10 best days of the stock market from 1992-2013, you’d net a 5.4% annualized return. What if you were even more cautious and missed the 40 best days because you were on the sidelines? Then your annual return would average negative 0.52% during that period. In terms of dollars, the less-cautious investor would have $318,304 over 20 years, and the more-skittish investor only about $90,000 after an initial investment of $100,000. What if you did nothing and stayed in the market the entire time? You’d have $637,807, or a nearly 9% annualized return.
Money manager C. Thomas Howard, professor emeritus at the University of Denver and author of Behavioral Portfolio Management says you need to take a long-term view of the market, preferably with a “20-year-plus horizon.” Even into retirement you’ll need the inflation-beating growth that stocks offer. “What happens today, next week and next year is relatively unimportant,” Howard says.