Question of the Day: How Do Investors Respond When The Stock Market Goes Down (Hint: Losses Hurt)?

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Oct 16, 2014
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Behavioral Finance, Question of the Day, Investing, Stocks

The stock market is a risky place which is a concept often forgotten during a bull market, especially the current one.  Here are some numbers that have emboldened investors in the last five years:  the S&P500 has risen almost 200% since it bottomed in 2009.  The market has not dropped 10% (often defined as a correction) since October 2011 so investors have enjoyed an upward trajectory.  To understand how unusual that is, Capital IQ reports that the typical correction occurs every 1 1/2 years.

Why does this matter?  Well, the last few days have been quite volatile in the stock market which saw some indexes come close to correction territory, where they have fallen almost 10%.  Investors who may have said they were in stocks for the long-term suddenly behave differently when they see their stock portfolios drop by 10% over a short period of time.

This might make an interesting Web Quest to send students out on the web to capture the psychology and emotion of investors over the past few days.  Here is a sampling of articles that you might share with students:

  • To the extent that a picture is worth a thousand words, this image captures the psychology of investing well (Dividend.com):

Investor-Psych-Line-1

  • What is worrying investors (Kiplingers)?  Here are at least five things:  Global economic slowdown, strong US Dollar which hurts exports, plunging oil prices, geopolitical instability and Ebola.  This article helps students make the connection between world events and how they impact the stock market.
  • Question from reader of The Globe and Mail shows how investors can be worried about 1) losing money 2) fear of being left out if market goes up.  Would be interesting to have students come up with an answer to her question:  “The markets are going through quite the “meltdown” and I know that the worst thing to do is to panic and sell my investments but I am getting really uneasy with it. Is there something else I could or should be doing? With my luck I feel that if I sell then the market will turn up and I will be regretting selling. What should I do?”
  • Huffington Post headline hits what is on many investors’ minds:  Should I Sell?  The bold print below is mine since I think that is the mantra that investors should repeat during times of stock market turmoil.

During times of increased volatility, I get an unusually high number of inquiries from clients and other friends about what they should be doing to prepare for a possible market downturn. “Do I sell now? When should I sell? Where should I put the money? Do you think this will be a big one, Michael?” The anxiety is exacerbated by a number of external risk factors that are covered ad nauseam by the various media outlets: Ebola, Ukraine and Russia, Hong Kong’s independence, Europe’s stagnation, slowing growth in China, or ongoing strife in the Middle East. Investors are barraged by bad news daily. Major news stories lead directly to one of the biggest pitfalls of investing: becoming distracted by all the noise that may not be relevant to a long-term investor’s particular situation.

  • About the Author

    Tim Ranzetta

    Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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