When U.S. stocks, as measured by the S&P 500 index, fell 13.52% in 2018’s fourth quarter, many felt like the market was in the midst of a major collapse. And their behavior showed it.
In December alone, U.S. investors pulled $143 billion from actively managed funds. This was the biggest monthly outflow ever recorded by Morningstar. Those billions of dollars sent to the sidelines to be parked in cash or moved to another fund manager came during a particularly violent three weeks, concluding on Christmas Eve. Their timing couldn’t have been worse.
The S&P 500 index bounced back sharply after Christmas and returned 8.01% in January alone. Anyone who sold out missed the bounce and gains.
This emotional reaction and subsequent bad investor behavior shouldn’t come as a surprise. Over the years, a plethora of research has consistently found evidence of this bad behavior repeated time and time again. Studies from Morningstar, Vanguard, Dalbar, and others have showed poor investor behavior causes actual investor returns to lag the returns of funds they invest in by 1% to 2% yearly. So, while the fund you invest in may earn 8 percent, due to using a fund’s track record to select the fund and bad investor behavior after buying the fund, you earn 6%-7%.
Let’s chalk the 2018 fourth quarter and first month of 2019 to another lesson learned. We can’t stop our emotions from firing a sense of fight or flight. But while this response may save us in some instances, in investing it tends to cause financial harm.
Having a disciplined, science-based investment process to avoid emotional responses can help you avoid financial harm and earn returns commensurate with the risk you are taking. If this is something you haven’t been able to do on your own or your current advisor seems to be caught up in the emotional herd with your money, perhaps it’s time to seek a second opinion from an objective Certified Financial PlannerTM professional that diligently follows such a process.
