Emotions can play devilish tricks on even the most savvy investor. For some, their deepest, darkest fears aren’t of ghouls and goblins, but bear markets and bad bets. While fear’s job is to keep people safe, it can also come at a hefty price when it starts to impact investment decisions. Fear casts its spell on the unsuspecting investor, making them behave in ways they might normally not. To defeat this boogeyman, it helps to know what traps are being set forth in one’s path.
Herds, Headlines, and Hoodwinks
Fear can be caused or amplified by what others are doing and saying. When markets are already volatile and an investor is already on edge, a sensationalized headline might just tip them over the edge and make them do something rash. If it seems like everyone else is reacting in a certain way, the investor might go against their better judgement and act impulsively.
Herd mentality and headline risk are just two of the sparks that lead investors to sell in a panic. Panic selling tends to lock in losses that may have otherwise only been temporary had the investor held their assets. Selling in a panic also robs the investor of the market recovery that would likely have erased the losses they panicked about in the first place.
As difficult as it might seem, investors have to remember in these moments that context is key. Markets are influenced by a variety of factors and short-term fluctuations may not reflect the overall health of the investment. Making a knee-jerk reaction out of fear, without looking at the broader context and considering the long-term implication of a market move or particular headline can leave investors worse off than if they’d stayed invested.
Cash in the Crypt
Fear is a two-headed monster. It can cause an overreaction, but it can also cause an underreaction or no reaction at all. Paralysis by analysis, as they say, happens when the fear and overwhelm of making any decisions at all leaves investors stuck. This paralysis might leave them in a portfolio that no longer meets their needs or isn’t equipped to handle the market’s momentum. Doing too much can be a curse, but so can doing nothing.
Then there’s the possibility that the fear of losing money is so great that risk-averse investors keep their money in cash, forgoing stocks altogether. Before the interest rate cut in September, roughly $7.6 trillion was sitting in money market funds. The tight grip on cash this year may partly be due to market volatility and partly due to favorable yields on cash. But the recent cuts and expectations of more this year lead many experts thinking investors will realize some of that cash may be better served in the equity market. Besides, there are a variety of choices on the marketplace these days, many of which are built for the risk-shy investor.
CNN’s Fear and Greed Index indicates the markets are being driven by fear lately. It takes into consideration factors like stock price strength and breadth, market momentum and volatility, and the difference between stock and bond returns, among other factors. The biggest thing investors are afraid of, of course, is losing money. It’s a powerful fear because the pain of losing money is often twice as powerful as the pleasure of an equivalent gain.
But don’t let a spooky market trick you. Stick to the financial plan to defeat the frightful boogeyman.