- Smart Investing
Did you panic sell during the latest market correction? Don't worry -science explains why.
So, did you get through the latest market correction with your nerves and your portfolio intact? On our site, we talk a lot about investing for the long term and resisting the urge to try and time the market - leave that to the professionals who have teams of people working to gain that slight advantage over the rest of us. But even those professionals are often wrong. On February 5, Keith Speights (contributor to the Motley Fool, a well known source of investment advice) talked about all the stocks he was going to sell if the market kept falling <here>. Well, as we all know now, the market continued to dive until February 9, doubling the losses that Keith was talking about on the 5th. So, if Keith did sell has he indicated, he did it at the worst possible time.
But, but then the market rebounded, and has been gradually recovering ever since. We haven't returned to the record levels of mid-January, but we are back to where the market was in December, making the losses for most people not so serious. In fact, since you didn't sell, you actually lost nothing.
So the lesson here is one we continually talk about on our site - invest for the long term and leave complicated financial trading to the professionals.
Now, if you read Keith's blog in full, you'll learn that he didn't actually sell anything but was just going through the exercise to make a point - Keith, like other good financial advisors, cautioned against panic selling. But don't think that many people didn't bail out at the worst possible time. There are even behavioral scientists who study and try to understand why people make bad investment decisions based on emotion and not based on facts and good long term strategies.
It might seem crazy but consider the study reported in Scientific American where a friend offers to flip a coin and pay you $20 if it lands on heads. If it lands on tails, you were give her $20. Most people wouldn't take that bet and in fact, for most people, the possible win would have to be double the possible loss before we'd take that bet.
That behavior makes no sense at all, math and probabilities would tell us that the original bet offered by your friend is neutral - over the long term, you would tend to break even. If your friend gave you $21 for a head and you paid $20 for a tail, you should take that bet every time as you'd come out ahead over the long term. But those studies reported in Scientific American showed that most people would need a head to payout around $40 before they'd sign up for the bet where they could lose $20 on the tail. This tendency reflects loss aversion, the idea that losses have a much bigger psychological impact as gains of the same size.
So, when the investors fears a loss, they act, often causing panic selling. It's in our nature and it has happened throughout history. They key is to understand your emotional response, stay focused on your strategy and long term investing goals, and make rational decisions.
But if you did sell at the bottom of the correction, don't beat yourself up - it's just human nature.