The stock market has had downturns and crashes before, but this time is different. This time the forces that caused the downturn are so bad that we will never get out of this mess. This time, the market may never, ever, ever recover!
Ok, I don't really believe that.
I just finished reading the book "Irrational Exuberance." This was a good read about investor psychology's impact on the markets (in the case of this book, the over valuation of the market in 2000, caused in part by the bandwagon effect). I wish had I read it before 2001, although I'm not sure I would have been convinced to sell my stocks at that point. I really thought at that time, "yeah, things seem out of whack, but this time is different, it's a new era, the age of the Internet."
So I found the book interesting, even in this time of market turmoil, because I suspect the same psychology is occurring now, in the opposite direction. People are thinking: "this time really is different."
But it never is.
In fact, it turns out that fear is a greater motivator of action than greed. So, as a group, we investors react even
more on the downside than we do on the upside. This article in the New York Times describes this "negative feedback loop". While I do think we probably have a lot more down to go (mostly because of this crowd mentality), it's good to be reminded that selling everything to "wait it out" is probably not the right approach. As this
other article in the New York Times points out, this approach is market timing--and if you wanted to do that, you missed your opportunity to sell exactly one year ago.
What's more important from this article is that over the last 40 years, a surprisingly small number of trading days have accounted for the majority of investor returns. If you miss those, you stand to permanently damage your long-term results: "Less than 1 percent of the trading days accounted for 96% of the market gains." So, if you sell everything and then miss these days getting back in, you are much worse off than if you just rode it out.
As to the idea that the market will never, ever, ever recover? The same reporter gives us a little perspective:
"This outlook is essentially a bet that our current predicament is so different that the equity markets won't bounce back at all, even though they survived 1929, the Great Depression, 1987, and a major terrorist attack. I do not believe that the markets are in some kind of permanent decline, and I haven't found an expert that does."
"If the entire financial system in this country does collapse, my IRA (and yours) will be worth nothing. But at that point, to paraphrase Jonathan from My Money Blog, I'll probably be more worried about food and guns than anything else."
Related Posts:
Retiring Into A Down Market--Part III (or Armageddon)
Will Somebody Please Wake Me Up From This Nightmare?
A Word About Asset Allocation
I couldn't agree more. History repeats itself again...and again...and again...
Right now everyone that looks at their retirement statement once a year has become worried. This is good, as that usually means we are close to a bottom.
Normally, I don't mention posts from my own blog, but I rather liked my recent post on market psychology, that touches on much of this.
I wish I had said:
"to paraphrase Jonathan from My Money Blog, I'll probably be more worried about food and guns than anything else."
It's so true. You won't be worried about money in your mattress if everything drops 80-90%. I wish I would have said it. I actually have done my personal emergency planning to that level. Not that I think it will get there, but better safe than sorry.
Posted by: Chad @ Sentient Money | October 10, 2008 at 09:05 PM
Its always the same. Please think the present crisis is so much worse than every before because this is the one we're currently in.
and
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Posted by: meg | October 12, 2008 at 01:05 PM