The markets have gotten off to a rough start in 2016, giving investors the equivalent of a nasty New Year’s Eve hangover.
Market corrections are normal occurrences in the investing world, taking place about once per year on average. Nonetheless, absolutely no one enjoys the stress, anxiety, and abject fear they can create.
But how investors react to events can make the difference between ultimately reaching their financial goals or falling far short.
Most people are programmed to react emotionally to negative (or positive) market events. It’s hard not to; it’s been hard-wired into our brains as part of a fight-or-flight impulse ever since we struggled for survival in prehistoric times.
Watching the media circus on CNBC and other “infotainment” channels – complete with clanging bells and hysterical hyperbole – only heightens the climate of fear. After a few hours of watching gloomy coverage and plunging markets, the average investor’s knee-jerk reaction is to want to sell everything, fearful that if they do not, there will be nothing left to sell.
Unfortunately, once they cave to that emotional impulse, they’ve sealed their fate. They’ve turned a temporary loss into a permanent one.
Behavioral finance expert Jay Mooreland, author of “The Emotional Investor,” explains the difference between temporary and permanent losses.
Temporary losses are both normal and expected. They occur each time the markets experience a pullback, and as we know, markets routinely go up and down. That’s just part of a normal cycle.
Pullback are temporary in nature, and may last a few days, a few months, or even longer in the case of a true recession.
But importantly, market prices rebound after the pullback, and continue to climb to new highs. That’s happened after each correction and recession in modern American financial history, including the Great Depression and the 2008 financial meltdown. Pullbacks drive down prices, says Mooreland, and these “temporary losses create fantastic opportunities for investors.”
But if nervous investors use pullbacks to sell, not buy, they permanently lock in losses, and may never recover. Emotional investor behavior, not declining markets, is “the primary reason permanent losses occur,” explains Mooreland.
And while we have no crystal ball, the evidence we’ve seen to date does not point to a recession. It points to a market facing several uncertainties that will probably struggle before finding new footing. There will undoubtedly be more rocky days ahead, but keep in mind that for long-term investors – especially those investing for a several decades long retirement horizon – the losses we see will be temporary ones. Those losses can only become permanent if you lock them in by selling.