When we sense trouble, we react quickly without always taking time to think through situations carefully.
When we see headlines screaming ‘panic’ and ‘sell’, the investor, scared of losing his/her money, sells.
The problem the investor then faces is when to buy back into the market.
By rushing to sell, the investor may lose any profit they have already made, and runs the risk of greater losses due to fees and market uncertainty.
Remember, when markets are falling, stock prices are falling – you can only sell if there is a buyer to sell to. If a buyer is found, you should then ask, ‘if the buyer thinks the stock is cheap enough to buy today, why am I selling it’?
Many investors do not ask this question as they are too keen to get out of the markets.
That is why I often hear investors say, ‘I don’t buy equities as I lose too much money’. It is not the equities that have lost the money, it is the result of investors’ behaviour based on their faulty reasoning.
If you stay invested and the markets keep falling, you become anxious about the money you have lost – particularly when you could have pulled out earlier.
If the portfolio value falls below the amount you invested, you now have a paper loss, but if you sell you will create a real loss. If substantial, this loss creates a real fear. Can you really afford to lose this money?
The worst scenario is that the investor’s nerve goes and they sell at the bottom.
After a few months the markets begin to turn positive and the time for optimism begins, but the investor has been burnt and will not be burnt again, so they hold out just in case it’s a false rise.
The market keeps climbing, but the investor is still nervous about going back in. The media is now all excited and is talking about the bull run. Everyone’s making money, so at last the investor gets their optimism back and they jump into the market.
However, they may be too late because all the gains have been recovered and they still have their losses to make up.
Or the investor reinvests and then the markets fall, and the cycle of faulty reasoning continues.
Investing for today
Why do we invest if we are so scared that we will lose our money? We know that over time unless we invest in something, the value of our capital will decrease because of inflation.
The problem we have is that it is impossible to make good money decisions all the time. If we invested for today’s market conditions, tomorrow it could all change.