History has revealed that crises and extreme circumstances often inspire courage, innovation, and reinvention. That’s because we’re often forced to change our traditional approaches and ideas in response to our new environment, and as a result, new and incredible possibilities often emerge. We consider those who can find the opportunity amid challenges to be “thrivalists” at heart. These are people who address difficult circumstances head-on, finding ways to improve, reinvent, and ultimately, thrive.
We’re here to help you become a thrivalist with the right investment strategy and approach for both the environment and your personal goals. This “Investing with confidence” blog series can help you view the financial markets through the right lens, and ultimately, remain committed to your strategy, so you can thrive now and into the future. We’ve all heard the old adage to “buy low, sell high,” but the reality is, some investors do just the opposite—they buy high and sell low.
Taking a look back at market history, while factoring in behavioral science, shows us not only why investors react this way, but more importantly, how they can avoid it. If we have a better understanding of market volatility, the risks of certain investment strategies, and the value of a thoughtful investment plan (that you can stick to), we can invest with confidence and stay on track in pursuit of our goals.
Money means emotion
From 1990 to 2020, the S&P 500 Index’s annualized gain was 7.5%, while the average equity investor’s return was only 2.9%, a difference of 4.6%.* Why is this the case?
Behavioral scientists have discovered that money activates the emotional part of our brains called the amygdala. This part of the brain is commonly known as our “lizard brain” because it’s instinctual and drives us to act on emotion without thinking through our decisions.
So when stocks are falling, we’re driven by fear, which motivates us to sell—even though it ultimately may not be in our best interest. And when stocks are rising, we’re driven by excitement and adrenaline, which motivates us to buy—even when that may not be the best strategy.
This isn’t an uncommon issue, either. As a group, investors tend to sell when the market’s moving down and buy when it’s moving back up. In fact, it accounts for much of the market’s volatility.
But going with the flow can mean we could potentially lose out on a lot of money or put our long-term plans at risk.
So how do we handle this age-old issue? We can start by taking a few steps:
- Understand how we’re wired to respond to market volatility.
- Refresh ourselves on market history.
- Look at the risks of following the herd, as well as the potential benefits of going against the flow.
- Make a plan to respond to volatility ahead of time and stick to it.
This post means we’ve already accomplished the first item on this list, so the remaining posts in this series will address the other three. The good news is our brains are incredible organs. They can be trained to respond a certain way. By knowing ahead of time what to expect and having a plan for how to react, we can fight our natural instincts to react in the short term and potentially have more success investing in the long term.
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* Source: LPL Research, Bloomberg, DALBAR, ClearBridge Investments 6/30/21
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composite and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
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