Has recent stock market volatility got you feeling uneasy and queasy?
You're not alone.
And, it’s not just the financial markets that seem to be going haywire...
We are concurrently and not unrelatedly experiencing levels of volatility and velocity in the political arena that were heretofore expletive undreamed-of.
It is hard to believe that with all these gyrations, the US stock market is actually up so far this year.
Stock market volatility - which means folks are buying like crazy one day - or minute - and selling like crazy the next - is an expression of our collective uncertainty.
And uncertainty makes us uncomfortable. And irrational.
Behavioral economists Daniel Kahneman and Amos Tversky* won the Nobel Prize (2002) for their theory of the heuristic – that is the mental shortcutting – which leads to completely unreasonable behavior regarding uncertainty.
Technically called “Prospect Theory,” Kahneman and Tversky used a series of tests to show that we experience the pain of loss much more acutely than we delight in gains of the same size.
Our fear of loss and related fear of uncertainty may have helped us survive as a species. Perchance those who chose not to eat the mystery berry lived to reproduce while those who gobbled never got the chance.
However, irrational loss avoidance is a highly harmful heuristic for homo investitor.
Research shows that selling on days when the markets are down – that is fear-based selling - leads only to more losses. Stocks nearly always recoup faster and more dramatically than we anticipate.
According to research from Invesco, it takes on average only three months to recover from a 5%-10% downturn and eight months to recover from a 10% - 20% correction.
And let’s remember, regarding the current market environment, we aren't even experiencing a downturn – yet.
As if to prove the economists’ theory, we don't recall much unease last year when the market was up, up, up.
Indeed, upside volatility just doesn't seem to snag our attention – or turn our stomachs.
At times like these, when downside vol might feel sky high, the advisor’s role is to:
1. hew to data,
2. eschew heuristics,
3. squeeze your hand,
4. splash some (proverbial) cold-water in your face, and
5. help keep you from misguidedly selling into the storm.
*Tversky technically didn't get the prize because he died in 1996 and Nobels aren't awarded posthumously. However, Kahneman gave Tversky equal credit for "Prospect Theory." The Undoing Project is a wonderful story of their friendship.
