The Fatal Flaw in Investor Psychology During Market Corrections

We’ve all heard the old stock market adage “Buy Low, Sell High.” But it’s easier said than done.

Investor psychology during corrections can play tricks with the mind and this leads many people to sell low and buy high.

In this video, Cary Stamp, CFP®, a Forbes Best-In-State Financial Advisor, explains the nature of investor psychology during a market correction, what to watch out for, and the best mindset for success.

 

TRANSCRIPT:
I’m Cary Stamp, founder of Cary Stamp and Company Financial Advisors. I’d like to talk about why investors often make mistakes when they’re looking at markets and when they should be buying and when they should be selling. There’s been a lot of science done, a lot of work on what we call behavioral finance and here’s a typical scheme of what goes through an investor’s brain as they’re looking at markets. It happens every single time the market goes down. I can almost tell you when people are going to start to call and when people are going to start to get disturbed.

If this side of the chart represents market value, and all of this shaded blue area represents where the market happens to be at any given point, as it starts to decline in the early phase, people start to get worried. They start to ask, What should I be doing? Should I be selling? Should I get out? Should I reduce the values? Hopefully, you’ve done the work in advance and established a risk level that would allow you and your portfolio to outlast this particular market decline. But it’s normal to still be a little bit worried.

Then when you’re getting to the phase where the market keeps going down, we start to get very nervous. We start to think that it’s never going to come back again, that this time is totally different, or we’re going to have a depression, or the financial media has said that this is going to be the worst one ever. It almost never pans out that way, at least it hasn’t in my 32 years of being a financial advisor.

What does often happen is that when somebody gets very, very nervous, they get to this phase that we call the selling phase. We also call this capitulation. It means they’ve thrown up their arms, they’ve said, I can’t take the volatility, I’m just going to sell now, take my loss and get out. Worst possible mistake any investor can make. It’s a lifelong decision that’s going to have an impact on how well you manage your finances, how much money is available for you in retirement, and how much money you can leave to your children. Not the selling phase. That’s the buying phase, folks.

So what happens to investor psychology as the markets start to go back up? We start to go back up and people are a little bit skeptical. Is this a head fake? Is this really going to happen? Is the economy really recovering? Are there really some good things that are happening? I’m a little skeptical.

And as that market gets back to close to where it was, people start to get encouraged. Hey, this looks like it might be the real thing. And then we start to have conversations at cocktail parties about the hot stocks that our friends are buying and then we get very confident about what’s going on in the world, what’s going on in the markets, what’s going on in the economy. And we get to this phase, the buying phase. We’ve done this exactly wrong, folks. We’ve bought high and we’ve sold low. Don’t be a victim.

The ideal time to buy good quality equities is when they are down, not when they are up. So if you’re thinking about pulling back a little bit because you’ve got a dollar cost averaging program in place, don’t do it. Keep it going. If you’ve got money that you’re putting into your 401k every single month, keep it going, keep it on. Eventually, you’re going to get to this phase and you will be glad that you didn’t jump out of the ship when it was at the very bottom.

I’m Cary Stamp and this has been a Principled Wealth Moment.

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