Back in the grip of market anxiety during the global financial crisis, I penned an article entitled “Do Something”, which referred to the natural human reaction we humans have to react to bad news.
My research on investor behaviour provided more anecdotal evidence that our natural reaction is to sell after bad news (when the market is already down) and buy when news is good (after the market is already up). In other words, sell low and buy high.
Knowing that we’re fighting this tendency to do the wrong thing at the wrong time, here are a few things to keep in mind:
Remember the “why”
Almost every time you make a rash decision based on past market performance, it’s a mistake. Investment decisions should be made based on your goals and not the market. Make changes when your goals change and ignore the market.
Incorporate new information slowly
Of course, you learn things during market corrections, and what you learn may change your goals. During the huge decline of 2008-9, many of us learned what risk really meant. Before that, risk was an abstract concept, but it became very real then. That experience might have changed your goals. That would be a reason to make a change to your investments. But even then, be patient. The time to think about going for a swim is not when you’re already in a life raft. Wait until things settle down, your anxiety settles, and you can think rationally about the next course of action.
“Have you seen what the market is doing?”
This is often what people say when they are in a state of shock and ready to go to cash “until things clear up.” Notice the implication that the market is “doing” something. The reality is that all we know what the market has already done. We have no real idea of what it will be doing tomorrow or next week.
Jumping out of the pan and into the fire
Going to cash until things clear up does not reduce stress. When you sell because you just can’t handle the pain anymore, you have a new problem: when to get back in. Unless you decided that your new plan does not involve exposure to the market (see Nos. 1 and 2), you now must decide when to re-enter the market. The most common “plan” is to buy back in when things have “cleared up,” whatever that means. If that’s your plan, stop and take the time to define what the world will look like when things have cleared up.
Will the news be better or worse than today? Will the economy look better or worse? Will CNBC be a happy place or a sad place?
Now think about this for a second, do you think the market will be higher or lower when things have cleared up? Of course, the market will be higher when things clear up. So now we’re talking about a plan to sell low and buy high on purpose.
If you have a plan, sit there
You would never plant an oak tree and then dig it up every time the wind blows to see how the roots are doing. If you feel so anxious that you absolutely must change your thought-out, rational plan, try writing yourself a letter to prove your case. Then seal it. Open it when things “clear up”.
If you don’t have a plan, vow to make one
And stop repeating the same mistakes over and over. Stay in certificates of deposit until you have a plan.
None of what I’ve outlined is easy. It’s hard to stick to a plan when everything is screaming at you to abandon ship. I’m also not saying that the market will stop going down. But if you have carefully considered your investment decisions in the context of your life and goals, with a clear understanding of the risks you take when you invest in the stock market (no excuses here since we just lived through the best example of risk in decades), then now is the time to stick to the plan.