Investors Fear Risk
What makes such markets difficult to live through without panicking is that, on average, investors are highly risk averse. Nobel Prize winner in economics Richard Thaler, author of the book “Misbehaving,” has found that we tend to feel the pain of a loss twice as much as we feel the joy from an equal-sized gain. And that ratio increases with the size of the investment!
Research has found that losses even lead to heightened autonomic responses, compared to equivalent gains. Professors Guy Hochman and Eldad Yechiam of the Israel Institute of Technology studied the effect of losses on investors and noted that losses spurred higher physical responses, such as pupil dilation and increased heart rate. This was true even for people who weren’t naturally averse to losses.
So, if your investments are causing you to feel stressed, do not feel bad about your anxiety; your feelings are normal. However, the first step to addressing a problem is to admit its existence. Even if you have a well-thought-out plan that anticipated such declines, as the well-worn saying goes, all plans are great until the first shot is fired. Similarly, renowned philosopher Mike Tyson famously quipped that everyone’s got a plan until they get punched in the mouth.
If you’re feeling punched, it’s normal. However, it may mean that you were overconfident in estimating your ability or willingness to take risk. If that’s the case, a review of your plan is in order to determine if you could meet your financial objectives with a less risky portfolio. It’s better to admit the error now, and correct it, than to run the risk of much deeper losses that might lead to panicked selling and/or the failure of your financial plan.
Later this week, I’ll share further thoughts on volatility and bear markets that I hope you will find helpful.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.