This quote about investing in stocks may be many years old, but it applies like new based on the last 10 days of stock market trading.
A downturn in the investment marketplace creates a natural fear for even the most experienced investor. When something is cutting away at our net worth, we want to stop it as soon as possible. We want to do something.
Here’s the problem: Leaving the markets in that environment is generally a bad idea, because it’s done out of fear. People make the biggest investment mistakes when they’re fearful. It’s even more powerful than greed, and there's proof.
Daniel Kahneman is a research psychologist, but he won the 2002 Nobel prize in economics for his work in an area now referred to as behavioral economics. His research reveals that the response to a price drop generates a much stronger emotion than a response to an equal price gain. In short, he found that most people fear loss much more than they enjoy success, and this makes fear a powerful enemy of an otherwise level-headed investor.
If we feel the urge to reduce our stock or bond allocation during a market downturn, our challenge is to recognize Kahneman’s observation. We need to remember that we picked our asset allocation target during a period when we weren't emotional, and did it for good reason. We must also remember that short-term market movements are of little-to-no consequence if we have a long-term investment horizon.
That said, we should do something during a big market correction -- but not leave the market. Rather, we should rebalance to our pre-chosen allocation target, effectively buying more stocks or bonds at a time when we may fear it most. Then later, when those markets inevitably recover, we should try to enjoy our success more!
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