When Stocks Go Wild, Here’s How Investors Can Minimize Damage
If your impulse is to sell when stocks plunge, here's how to first do no harm.
-- Do you tend to react emotionally to headlines, economic news and market gyrations, buying or selling impulsively and deviating widely from your investment plan?
If so, you’ve got lots of company among individual investors, according to DALBAR, an investment research firm that does an annual study of investor behavior. The study routinely finds, and once again found this year, that individual investor behavior is typically what finance nerds call “sub-optimal.”
Those investors’ errors result in portfolios that vastly underperform major indexes. They’ve been historically prone to make serious errors by reacting impulsively to major market events, such as the stock market crash in 2008, and most recently the major declines touched off by trouble in China.
Misguided individuals tend to sell in reaction to falling values, only to get back in after prices have started to rise. Thus, they sell low and buy high. Not only is that the opposite of the goal of investing, it makes no sense from a process standpoint. If you deviate enough from your investment plan, you don’t really have a plan anymore; you’re just making things up as you go along.
Recent stock market events presented circumstances ripe for such missteps. The Dow Jones Industrial average started August at about 17,598. Amid the turmoil that developed late in the month, the Dow dipped about 6 percent to 16,528 at month’s end. August turned out to be the worst month for the Dow since May, 2010.
Meanwhile, the S&P 500 had its worst month since September 2011, and the NASDAQ, since May, 2012. All the while, measures of market volatility – the degree of fluctuation in values (informally called the fear index) – just about leapt off the charts, registering the most abrupt changes since the 2008 financial crisis.
Doubtless, the record will eventually show that, consistent with historical patterns, many investors deviated from their plans last month, reacting to the plunge by selling.
Naturally, there’s a low likelihood of gain for the average investor caught up in this syndrome. These people are taking their eyes off the prize that can be obtained from disciplined long-term investing. If they would just realize that the short-term warp and woof of the market doesn’t really matter much in the long term, they wouldn’t shoot themselves in the foot by over-reacting to price drops.
Such self-defeating moves stem from misconceptions and misguided behavior examined by the DALBAR study. Other examples cited in the study include:
So take a hard look at your investing habits. Are you guilty of any of these behaviors? If so, consider these points:
It may be OK to scratch an itch occasionally, but if you lose a short-term bet, don’t keep doubling down just because you can’t admit you were wrong. If you must stray from your asset allocation, invest minimally so as not to abandon the risk protection it affords.
If they move a few extra percent of their total investments into dividend payers at the wrong time, such poor decisions don’t tend to hurt much. But if you get fixated on the notion that your hunch that a hot stock will stay hot is right and liquidate too many current holdings to dive into it, you need a reality check.
So when the market tanks, don’t think in terms of having lost money. Paper losses are only real if you sell. Instead, remember that you built a portfolio to withstand the risk of one or more parts of it sinking. Sit back and weather the storm. And if the market is ascending, don’t let greed take over. Take comfort in the gains you’re getting from your current, well-allocated portfolio, knowing that it’s also protecting you from risk.
Any opinions expressed in this column are solely those of the author.
Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.
It may be OK to scratch an itch occasionally, but if you lose a short-term bet, don’t keep doubling down just because you can’t admit you were wrong. If you must stray from your asset allocation, invest minimally so as not to abandon the risk protection it affords.
If they move a few extra percent of their total investments into dividend payers at the wrong time, such poor decisions don’t tend to hurt much. But if you get fixated on the notion that your hunch that a hot stock will stay hot is right and liquidate too many current holdings to dive into it, you need a reality check.
So when the market tanks, don’t think in terms of having lost money. Paper losses are only real if you sell. Instead, remember that you built a portfolio to withstand the risk of one or more parts of it sinking. Sit back and weather the storm. And if the market is ascending, don’t let greed take over. Take comfort in the gains you’re getting from your current, well-allocated portfolio, knowing that it’s also protecting you from risk.
Any opinions expressed in this column are solely those of the author.
Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.