Stay calm. Don’t make any sudden moves. Just wait it out and it will turn out just fine. These are the things that financial pros and calmer heads say to do in times of stock market turmoil.
This is your brain on stress: “RUN FOR THE HILLS! GET OUT WHILE YOU CAN! STAY AWAY UNTIL IT’S SAFE!”
Behavioral finance experts at Oxford Risk, a London-based risk management software firm and consultancy, figured out just how costly it can be to heed the advice of your inner caps-lock voice. They calculated that increasing your allocation to cash can cause investors to underperform their less panicky peers by an average of 4% to 5% per year.
That range is what’s known as the “behavior gap” — the difference between the returns we earn when we make rational investment decisions versus moves driven by emotion, during times of stock market turmoil.
Our vision narrows when we face a crisis. We intensely focus on the present and lose sight of the big picture.
On average, the behavior gap costs investors around 1.5% to 2% a year over time. That’s due to our propensity to invest more money when times are good and less when stocks are down. In a decidedly not normal year like we’re having now, the price is a lot higher when you let your feelings take over your trading behavior.
By focusing so intensely on the clear and present danger, we lose sight of the big picture and long-term effects of our actions. While there are some universal workarounds to self-destructive investing behavior (which we’ll get into in a moment), overcoming your natural impulses depends on exactly how your brain is wired.
Our somewhat predictably irrational behavior
Despite our complex brains, what most people do when facing a financial shock is fairly predictable. Basically, we act like scaredy cats. Except instead of freezing with fright — which would actually serve us better in the long run — we’re driven to take some action.
The most common move is to overindulge in the investing equivalent of comfort food: Cash. We move our money out of the market and into this safe haven where we can hang out for a while without worrying about the storm cloud over stocks.
Sure, we’ve de-risked our holdings. But we’ve exposed ourselves to other types of risk by rearranging our portfolios. That’s how we end up underinvested in certain sectors and lacking the proper diversification to provide a good balance of growth and stability.
Another risk is getting too comfortable with money sitting in cash. Just ask any investor who was still sitting on the sidelines when the March stock market crash did a quick about face. There’s nothing worse than realizing you did the exact opposite of buying low and selling high.
What are your weak spots?
Despite the similarities of our investing mistakes, not all investors are irrational in the same way.
Oxford Risk developed a consumer version of its Financial Personality Assessment to help investors pinpoint the right action (or inaction) to take based on the way you’re wired.
Unlike traditional risk profiling, which focuses on a person’s tolerance for volatility, the Financial Personality Assessment looks at how you feel about your finances, your future, and how you’ll react when the markets get jumpy.
“Long-term plans should be looked at through long-term lenses.”
In its research, Oxford Risk identified six dimensions of financial personalities that affect how we cope when in crisis. The dimensions cover everything from impulsivity, confidence and composure to how much a person needs to be involved in making investing decisions to feel comfortable. After rating where a person falls on a scale of low, medium and high, the assessment provides methods investors can use to resist their most damaging compulsions.
For example, someone who rates low on composure is, according to the assessment, more likely to trade too frequently or be tempted to sell off everything when the markets crash. To counter those tendencies, Oxford Risk suggests staying in regular contact with an advisor or friends with long-term perspectives. You’d also do well to impose a 24-hour cooling-off period before acting on any investment decision.
An investor with a low internal locus of control tends to believe that investment success is more a matter of luck than hard work and discipline. This person would do well to rely on systematic investment approaches (picking a target-date mutual fund that is automatically rebalanced, for example) rather than trying to guess when the right time is to move money around in a portfolio.
There are also universal actions that can help all investors avoid sabotaging their own returns during times of stock market turmoil:
Don’t turn paper losses into real losses: Until you seal the deal by selling out of investments, your losses are only virtual. Give them time to recover, especially if you don’t need the money in the next five or 10 years. (Any money you need to access in the shorter term is too precious to expose to the short-term stock market movements.) Similarly, keep contributing to your 401(k) or other workplace retirement plan.
Remember that the investments on the news aren’t your investments: “Long-term plans should be looked at through long-term lenses,” says Oxford Risk CEO, Marcus Quierin, PhD. Staying glued to the ticker tape and every market update serves no purpose other than to increase your anxiety. Even if companies that you own are making news, remind yourself that they are just a part of an overall portfolio built with a long-term strategy in mind. And if you do decide your portfolio is out of whack, here’s how to rebalance it.
Focus on what you can control: We’ve emphasized this at HerMoney time and time again. There are a lot of things that are in your power to change. Market movements aren’t one of them. No one reliably can predict what’s going to happen with stocks, except that, based on a hundred years of returns, the market increases in value over the long term. You can take advantage of that trend as you hang tough when there are sudden stock market moves.
More on HerMoney.com About Thriving During Times Of Stock Market Turmoil:
- HerMoneyPodcast: Carl Richards on how to make good decisions during uncertain times
- Yes, you really do need to invest in the stock market
- 5 things to do with your investments instead of selling
- How anxiety and depression take a toll on your finances
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