When it comes to getting great results from your investment portfolio, our advice has always been crystal clear; Make sure you have enough money set aside to meet your short-term expenses, and invest the remainder in a properly diversified portfolio of good quality investments for the long term. Don’t try to second-guess when markets will rise or fall, and don’t panic when things don’t go well in the short term.
A recent study examined the circumstances when people do ‘panic sell’ their investments, and it makes interesting reading. Men are more likely to panic sell than women, and left to their own devices are consistently more likely to sell as the market goes down (and buy as the market goes up), in contrast to professional investors who tend to do the opposite.
Too much confidence
Studies of investor behaviour have long since recognised that overconfidence is a significant factor in making poor investment decisions. It is striking that the research shows that those people who declared themselves to have excellent investment experience or knowledge were actually more likely to panic sell in response to changes in value of their investments, rather than taking a measured response. Men are particularly prone to this, as they tend to be more confident in their skills (skills they don’t have) than women and therefore more susceptible to making poor decisions in practice.
The study, When Do Investors Freak Out? Machine Learning Predictions of Panic Selling, published in the Winter 2022 issue of The Journal of Financial Data Science, used a dataset of 653,455 individual brokerage accounts belonging to 298,556 households. It documented the frequency, timing and duration of panic sales, defined as a decline of 90 percent of a household account’s equity assets, of which 50 percent or more was due to trades, over the course of one month (in other words, moving most or all of a portfolio into cash). Their data sample covered the period 2003-2015.
The data showed that 9% of households engaged in panic selling across the 13 years between January 2003 and December 2015. Of those who “freaked out”, 81 percent did so once, 11 percent did so twice, and the remainder did so more frequently.
One-third of panic sellers fail to return
The authors noted that panic selling can act as a stop-loss mechanism in rapidly deteriorating markets, and that can sometimes prove beneficial. However, that depends on investors returning to the market in a timely fashion (selling means you have to be right twice), and they found that almost a third of those who engaged in panic selling never returned.
The authors identified five distinct types of individual investors: passive investors, extrapolators, risk avoiders, contrarians and optimistic investors. They found:
Extrapolators (27 percent) tend to decrease their equities allocation following bad market performance and increase it following good returns, extrapolating past trends (buying high, selling low - the opposite of good practice).
Passive investors (35 percent) leave their allocation unchanged regardless of conditions.
Risk avoiders (19 percent) significantly cut their equities allocation when they see large moves in the stock market in either direction. This group had the lowest average age, predominantly consisting of millennials.
Contrarians (8 percent) tend to increase their equities allocation following bad market performance and decrease it following good returns — they act like institutional investors.
Optimistic investors (11 percent) tend to increase their allocation in either scenario
Based on their findings, the report concluded: “Because individual investors tend to have extrapolative reactions, while institutional investors tend to have contrarian ones, we conclude that institutions generally take the other side of individual investor trades in broad asset allocations.” In other words, it tended to be institutional investors who bought the cheap investments that undisciplined private investors were selling, and sold the expensive investments that those same investors were buying.
Whilst we completely understand the emotional pain that arises from watching your portfolio fall in value in times of uncertainty, we remain convinced that staying the course, allowing your investments time to recover, and sticking to your Plan, is your best response in difficult times. We have 30 years of working with our clients as evidence that this approach works.
If you'd like to get started on creating a Plan for life and for living, contact us today for an initial conversation.
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