Do you ever feel like the stock market makes your head spin? If you’re like my daughter, sometimes there is so much spinning that you end up on the ground.
Notwithstanding the shameless plug to showcase my adorable little girl, market volatility can be a real whirlwind to navigate. To quote Ron Burgandy, the ups and downs in your portfolio can often feel like you’re in a “glass case of emotion.”
Allow me to introduce you to two brilliant individuals you might not know about. The first is Daniel Kahneman. Daniel is a psychologist that specializes in decision-making and behavioral economics. The second, Amos Tversky, was a mathematical psychologist (yes, that’s a real thing) that focused on cognitive bias and its impact on handling risk.
These two men collaborated on a study in 1979 to study the principle of “loss aversion,” which eventually won a Nobel Prize in 2002. In summary, the study concluded that the impact of losing something is two times greater than the impact of acquiring it. [1]
To emphasize this point, the feeling of pain attributed to losing money is so powerful that most people are willing to take less risk even when greater gains are available.
Any investor that has lived through a boom and a bust understands the challenge of navigating the peak of the market and the bottom of the market. At the peak, people tend to be euphoric. In December 2017, Bitcoin was approaching $20,000. It was all over the news, and maybe your friends (like mine) were talking about how they were going “get in.” Suddenly, everyone was a Bitcoin “expert” and it was all the rage. Euphoria had taken root. 2 months later, Bitcoin had lost over 65% of its value.
But at the bottom of the market, a different emotion shows its face. March 2009, the S&P 500 bottoms out after losing approximately 50% of its value. Many investors feel the weight of full blown depression, not just economically, but emotionally. They cut their losses at the bottom, just as the market starts to enter a historic bull run.
To suggest we should be purely logical investors is to forget we are human. But riding our emotions through the ebbing and flowing of the market is a fool’s errand.
Navigating the balance of logic v. emotion can make you dizzy. I asked my daughter’s dance teacher how professional ballerinas are able to spin so much, so fast and still stay standing… let alone continue dancing a complicated routine. The answer was simple. They develop their technique, and they train to pick a spot as they spin that keeps their mind centered. This helps them stay stable yet nimble.
Interestingly, navigating the market isn’t much different. Experience builds technique, and the best investors develop a process to sift through the minutia and volatility to make wise decisions over time.
Do you have a process to steer through market volatility? If not, I would encourage you to find one that can help you traverse the vast ocean of the market. At the end of the day, the people that consistently make it across the great divide have a working compass, a captain, and a crew that’s sailed through a few storms. They can’t control or predict the weather (and those that think they can are fooling themselves and their followers), but they know how to plot a course through a volatile sea.
Sources
[1] http://www.its.caltech.edu/~camerer/Ec101/ProspectTheory.pdf