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It is interesting to note that loss aversion is a term used in behavioral science where a real or potential loss is perceived by individuals to be psychologically or emotionally more severe than an equivalent gain. Year-to-date unrealized losses may weigh on investors, especially those who put large sums of money in the market at the peak. As the downturn in the stock market stretches into its sixth month, the S&P 500 has brushed with bear market territory on a couple of occasions and the NASDAQ has fared even worse (down 13 percent and 23 percent year-to-date, respectively). Analysts suspect the decline may not yet be over, but it is difficult, even for seasoned professionals, to call when the stock market will bottom, or how long a recovery might take.
The Behavioral Science Behind Fear or Flight Mode
The most severe reaction to prolonged market declines is to go into a fear or flight mode. Occasionally such fear unwisely drives investors out of the market at lows, at which point attempts at reentry can lead to investors missing out on the recovery, rather than staying the course. These fear-based mistakes are often followed by regret at missing out on successive gains.
How can an investor avoid making investment decisions based on emotions? By understanding why this can happen and evaluating the logic behind the desire to act. Behavioral scientists trace the fear response to the part of the brain called the amygdala. The hippocampus works with the amygdala to help the brain interpret the perceived threat. For example, it would be normal to feel paralyzed not knowing how to react when the brain is overloaded with information or to feel a need to take back control. This is the process of deciding how to analyze and react to new information. While these emotional responses are natural, when it comes to finances, it is advisable to talk through any potential actions with a trusted financial representative, who is best positioned to give personalized financial advice and suggestions during more turbulent periods.
While concerning, the prolonged market pullback is a combination of natural market forces and unforeseeable shocks such as the war in Ukraine and China’s zero-covid policy, both of which will hopefully be resolved in due time. Even in the midst of these events, however, there are factors that bring long-term investors optimism.
Strong performance in the stock markets to close out May is a sign of continued investor confidence that businesses will likely overcome near-term growth and inflation concerns. Improving data on the direction of inflation and/or easing global trade logistics could give more credence to the rally. Until then, market volatility may well continue until it finds a new level of support at which valuations are justified by future earnings. There are known and unknown risks. The stock market is widely accepted as a future predictor of earnings, but it can only take into account known risks. Surprises may yet swing the market in either direction. In uncertain times like these, buying into stocks at a lower cost frequently works out well for the long-term investor because market declines have historically tended to be short-lived. In such scenarios, automated payments can be perceived as purchasing at a discount. Each investor’s circumstances are unique, but in general, the top three factors to take into consideration given economic conditions today are:
- Investors may consider delaying retirement beyond full retirement age for a bump up in social security benefits to hedge against this year’s high inflation
- To the extent that investors are worried about selling from an investment account, investors may choose to hold off making large discretionary purchases until a recovery is in sight.
- Investors, who must make withdrawals for various reasons and have been participating in the market for some time, can take comfort in the knowledge that the S&P 500 returned an average of 14.7 percent from 2012 through 2021. The past decade generated above-average returns.
Lastly, investors should always keep their Financial Professional informed of any changes in circumstances (e.g., job, home purchase, a change in planned retirement date) that affect your long-term financial plan. Be well!
Provided by Ed Wettig, CFP, Cornerstone Financial Planning Group, which offers investment management, financial planning and retirement income strategies. Representative is registered with and offers only securities and advisory services through PlanMember Securities Corporation, a registered broker/dealer, investment advisor and member FINRA/SIPC. 6187 Carpinteria Ave, Carpinteria, CA 93013, 800-874-6910. Cornerstone Financial Planning Group and PlanMember Securities Corporation are independently owned and operated. PlanMember is not responsible or liable for ancillary products or services offered by Cornerstone Financial Planning Group or this representative.