The Cure for Hysterical Amnesia
Every investor knows that they are supposed to buy low and sell high. Even a child who doesn’t have any experience with investing can typically understand this concept. Then why is it that we tend to develop hysterical amnesia and forget this key principle when the market plummets?
Emotions are a strong factor in our decision-making, especially when it comes to something as impactful to our lives as money. Nobody likes to see the savings that they worked so hard for suddenly go down. So, it is natural that our flight or fight instinct would tell us to run to safety. But this instinct which protects us from immediate danger does not consider the long-term consequences. History has shown that the market does eventually rebound after major shocks, sometimes quickly like in 2020, and sometimes much more gradually like in 2009-10. The key for the long-term investor is to be there in the market for the rebound.
So here lies the secret challenge with selling after a drop in the market – you have to be right twice for this decision to pay off. Not only do you have to be right that the market is going to fall even more than it already has, but then you have to buy back in at the right point so you don’t miss the rebound of the market going back up again. I believe the first part of this is very challenging – when things go wrong in the economy, it is very difficult to know when this has been fully reflected in the markets or whether there is more drop to come. But let’s say for the sake of argument that you knew that the market was going to go down even further, then it would make sense to sell at that point, right?
The answer is no unless you also know when the market is going to start going back up again. Let’s consider the psychology of this decision – if you are fearful enough to sell when the market goes down 10%, are you going to feel any better after it goes down another 10%? Are you going to be ready to buy back in when things look even worse than when you sold in the first place? Typically not; instead, our fear subsides only when things improve which means the market has come back up enough to make us feel better about the future. We have set ourselves up to miss the rebound!
As an investment manager, I don’t promise my clients that I am going to beat the market. I personally have never trusted those who claim that they can. But I can offer a rational approach to investing for the long-term which removes the emotions that are inherent when investing your own money. And this kind of approach will help to avoid some of the buy high and sell low mistakes that so many people make with their own investments.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
About the Author
Neil Manning, CFP, AIF, CDFA, FSA
I am a reformed actuary turned financial advisor, helping my clients with everything from investments to retirement projections to LTC insurance since 2014. Unlike most normal people, I love numbers and finance – I’m currently reading a book about game theory which my wife and two teenage daughters think is unbelievably boring (they are wrong). For more details about my background, check out my website below.