Improving Investor Behavior: Managing Your Fears

Shark Week is among the longest running and most popular cable programs in history. First appearing 30 years ago in 1988, the show has since been watched and celebrated by millions. Why would a program about sharks and their danger be so popular? I think it plays on the emotion of fear, and more interestingly, people’s desire to be a little bit scared.

This is quite the paradox: some people enjoy engaging in an activity designed to make them uncomfortable. The same can be said for horror movies, especially at this time of year. In both circumstances, however, the fear is often wholly unfounded. Sharks are responsible for about six deaths per year, and I highly doubt zombies will be taking over the world anytime soon. Instead, people should be much more afraid of mosquitos with their death toll last year of more than 830,000 people.

My point is this: sometimes our greatest fears are the most unfounded. Whether it’s an oversized fish or monsters under the bed, our worst fears take up an oversized portion of our conscious and drive actions that can be damaging and counterproductive. Fear is a powerful emotion and one you must learn to rein in if you want to be a successful investor.

Psychological studies suggest that for investors, loss is twice as mentally powerful as a similar gain. So the emotional pain of losing $20 would require a $40 gain to offset. That’s a big problem when investors pay constant attention to their full portfolios and the swings happening at any given time.

If there’s one thing that’s important to understand: volatility does not create risk, risk creates volatility.

On a daily basis, the stock market rises more often than it falls (52 percent v 48 percent according to Forbes.) Over longer time periods the numbers only get better. The stock market return for the past 10 years, including the downturn of 2009 is about +136 percent according to Yahoo Finance. Investing is not for a day, week, or even year. We measure investment returns over long periods of time – why not use the same timeframe for measuring volatility? If we did, measuring volatility on scales of decades make most troubling events look almost non-existent. When bad news comes along, it feeds fear. Fear leads to withdrawals, and withdrawals lead to the volatility we see as investors. Stock market wiggles don’t create increased risk; rather it’s the investors jumping in and out – the ones allowing their emotions to get the better of them – that are at the root of increased risks. The wiggles represent fear, but they shouldn’t CAUSE fear.

But all too often they do. We recently were interviewing a prospective client who said “he was nearly destroyed” in the 2008 – 09 market decline, which caused him to move his investments out of the stock market and into less volatile certificates of deposits. Now that the market has rebounded he was considering a move back into the market, preferably with an aggressive strategy.

This is someone who let the wiggles dictate their investment strategy. He allowed fear get the best of him, and he sat on the sidelines for one of the greatest bull markets we’ve ever seen. Now, just as the market is entering what many financial professionals consider to be the later innings of the ballgame, this client wants to get aggressive.

As I write this article (Oct. 11), the market is digesting some fear. We’ve been in a period of steady growth since February and now, without warning, the market is responding quickly and sharply to a variety of news. It’s a scary point for many investors, but it’s not an uncommon occurrence. Drops of 5 percent happen, on average, three times per year according to data from American Funds. Drops of 10 percent usually happen about once per year.

The ghosts of 1929 and 2008 are burned deeply into the minds of many people. This fear is perpetuated with what feels like a never-ending stream of bads news. The result is investors let fear dictate their actions, driving an actions of selling low and then buying high.

It is interesting how financial pundits may appear to be “smart” when they are cautious or nervous about what might happen, what might go wrong, and how uncertain the future might be. If you use historical facts to judge their advice, you quickly realize that the “smart,” overly cautious perspective was more often than not, incorrect. Let’s face it, everything in the future is uncertain.

Comparison drives this fear as well. It seems only natural for people to compare. Comparing your progress to your neighbor’s, to those on social media, or even to your own idea of where you “should” be, is a recipe for trouble. The only healthy comparison to make is your current situation with your past. It is a comparison that hopefully demonstrates progress. Comparing your progress with an ideal creates anxiety, frustration, feelings of doubt, and even hopelessness. Measuring your progress looking back creates feelings of confidence, accomplishment, and happiness.

Learning to conquer your fears is an endeavor many spend their entire lives pursuing. While few will come face-to-face with a shark, almost all of us will need to stare down a bear market and all the emotions that come with it at some point. When the time comes, guard your portfolio and your feelings. Whether you’re feeling hesitation, fear, or even anticipation and excitement, recognize that these are emotional reactions, not logical ones. Fall back on your game plan, and use it to end up where you want to be.