15 Nov Overcoming fear when markets fall
Most of us would like to think we make rational investment decisions, right? Well here’s a chart courtesy of Russell Investments suggesting the opposite happens in practice. The area circled on the right hand side shows a big dip in the US share market in the December quarter of 2018. Coinciding with this dip is the largest outflow of money from US mutual and passive exchange traded funds over the last decade. Whilst not as obvious from the chart, similar instances occurred on a smaller scale throughout the last decade. Is this rational investing or is something else at play?
Data shown is historical and not an indicator of future results. Sources: Monthly mutual fund, passive ETF flows and Russell 3000® Index, Morningstar, Direct. Data as of February 28th, 2019. Index performance is not indicative of the performance of any specific investment.
The world of behavioural finance where theory, logic and rational thinking gives way to how humans behave in practice, helps us understand why we behave the way we do.
Russell Investments identifies five of the most common behavioural biases that impact money decisions; loss aversion, over-confidence, herding, familiarity and mental accounting.
The bias evidenced in the chart is “herding” where investors follow the herd when others are selling or buying. This results in selling investments when they are low in value and buying them when their value is high – the opposite to how we should think and act. Let’s suppose you had sold out of US equities at the end of 2018. Using the Russell 3000 index data, you would have locked in a negative 14% return for the December 2018 quarter and subsequently missed out on the recovery of 20% during the following 9 months to 30 September 2019.
Herding is a behaviour that’s easy to succumb to. How many of us in our everyday lives are comfortable with swimming against the tide by doing the very opposite of what everyone else appears to be doing? There are exceptions of course and one very famous investor does just that. Warren Buffett, the famed Oracle of Omaha and Chairman/CEO of Berkshire Hathaway puts it like this. “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
But when markets are having a melt down and there’s no end in sight, what are investors supposed to do? It may seem flippant but the answer could well be “nothing”. If you are a long term investor with a well-diversified portfolio matched to your investment horizon, why are you worried by what’s happening in markets today? If you are Warren Buffett, you’ll probably see this as a buying opportunity!
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The views expressed in this article are the views of the author. The information provided is of a general nature and is not intended to be personalised financial advice. You may seek appropriate personalised financial advice from a qualified Authorised Financial Adviser to suit your individual circumstances.