By Cory Clark

Special to the Financial Independence Hub

Nobody knows if we have reached the turning point in the year’s pandemic-induced market meltdown. The markets are not quite as scary as they were at the beginning of March when some markets lost nearly 20% of their value in a single day.

Some recoveries are rather swift, while others take a little more time, but there is one way to know when the market has reached its bottom … just kidding …. there is no way of knowing, and that’s exactly why the average investor should not be bailing out of their positions when storm seas get rough.

If you decide that you can’t stand the risk of loss and fear that goes along with it, the only way to sell and successfully mitigate losses is to make two correctly timed decisions. Not only must you sell at the right time, but you must also re-enter at the right time. DALBAR has been studying investor behavior since 1994, and it is painfully obvious from history that investors are not going 2-0 and timing it right on both ends.

The common rationalization for selling out at the worst time is that if you are not losing money, you must be better off, right? This an example of a dangerous investor behavior known as risk aversion, and from an economic standpoint it is an invisible hole in the bottom of your bucket. Investors love to make money, but they hate to lose that same amount of money even more. So being out of the market and avoiding a loss provides a measure of comfort, but being out of the market and losing out on a similarly sized gain tends to go unnoticed. But when looking at your investor statement, or when projecting future retirement income, money you lose and money you should have (but didn’t) gain will all have the same net effect on that bottom line.

Don’t get out if you don’t know when to get back in

The situation of today’s average investor perfectly illustrates in live action what DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has been teaching investors and advisors for years; don’t get out if you don’t know when to get back in.

Imagine an investor who reached their breaking point sometime in March, and sold their equity position with the intention of buying back in when the coast is clear. Not long after, the markets started to shoot back up aggressively, much earlier than anticipated. Now doesn’t that put this investor in a precarious situation? Who wants to be “that guy” (or gal) who buys back into the market after the biggest daily gain ever? If the recovery ends up being a false start, this investor could lose a significant chunk of his portfolio … AGAIN. So perhaps this investor doesn’t fall for a potential false bottom and continues to wait …. and wait … and wait … until the recovery is certain. Unfortunately, by the time the recovery is certain, it’s over and this investor has missed the boat. Continue Reading…