By Matthew Fassnacht, CFP® CFA® CPA
Learn more about Matthew on NerdWallet’s Ask an Advisor
I recently read an insightful article about truths investors know but do not accept. In this list, there was one standout truth that seems very relevant to the current market sentiment: “Fear is significantly more powerful than greed.”
Fear is among the strongest emotional motivators and drives human decisions in a way most other emotions can’t. When we are afraid, we instinctually take actions to eliminate our fears. Often these actions are not logical or rational, but rather a reactionary protective measure.
This helps explain why market declines generally accelerate at a pace that exceeds market gains. The U.S. stock market has seen this phenomenon in its recent history. Consider the crash of 2008. From Oct. 6, 2008, to year’s end, the Dow Jones Industrial Average closed lower on all trading days and saw record-breaking trade volume. The Dow dropped 18% in one week, the worst weekly decline in its history. By contrast, the Dow hasn’t gone up by 18% in a single week since 1931.
While there was a series of events that led to the selloffs, fear played an interesting role. Investors were afraid of a “systematic failure” of global economies and financial markets, upon which many had speculated. The events of 2008 have amplified a culture of fear in the U.S. equity markets that still exists today. Investors have hesitated to jump back into the market, and they exit the market quickly at the first feeling of unease (for example, July 31, 2014: down 306 points).
Although it’s easy to see the behavioral impact that fear has on investor decisions, there’s one more factor that fits into this nicely: the media. These days, there’s no shortage of negative commentaries and interviews with experts predicting market corrections or crashes. While it’s easy to let these articles influence decisions, proceed with caution. Websites that post these articles are rewarded for the scare tactic. These articles typically get a higher number of clicks and views than positive, optimistic ones.
For most investors, I believe, the fear of losing a portion of their investments is a stronger force than the thought of realizing a sizable return. The new culture of fear is likely here to stay, at least for the foreseeable future. With this in mind, I suggest that investors really think about their objectives (growth or capital preservation) and how much volatility they can tolerate in their portfolio. While a professional investment advisor can develop the appropriate strategy, only you can determine the level of fear versus greed that’s right for you.