Friday, August 18th, 2017

Fear was in the driver's seat

Posted: Monday, August 15, 2011

By Elaine E. Bedel, president, Bedel Financial Consulting

A lot of emotion was spent last week as we experienced some of the worst and best days of the stock market. After it was all said and done, the Dow Jones Industrial Average was down 1.5% for the week. Amazing!

Last Monday the DJIA lost almost 635 points, regained 430 on Tuesday, only to see that rebound reduced by another 520 points on Wednesday. We ended the week with a gain of 423 points on Thursday and another 125 on Friday. The net change for the week was a loss of 177 points or 1.5%.

There was a lot fear in the system as we started the week with the knowledge that the U.S. credit rating had been downgraded by Standard & Poor's. This downgrade was just one more straw on the back of the camel. Prior to the downgrade, Congress and the President completely destroyed any confidence the public may have had left in their ability to come together to address our debt and deficit issues. Unemployment was not improving, U.S. GDP growth had slowed down, and consumer confidence was waning. So what happened? The downgrade pushed many investors over the edge.

Market Expectations

Because psychology plays such a strong role in the market, no one can predict what the market will do this week. However, there are many reasons to believe that stocks are cheap.

Corporate earnings reports have been mostly positive, which means that companies are making money. Personnel reductions, expense controls and other factors have allowed corporations to become “lean and mean." They have avoided debt by stockpiling cash. Companies are gaining financial strength, but their stock prices remain low relative to historical measures.

Smart investors want to buy when it appears that everyone who wanted to sell has done so. This past week we saw investors taking advantage of the down market to add value to their portfolios. There were numerous examples of individual company values fluctuating anywhere from 5% to 10% in a day. It is illogical to think that a company’s value should change that much over a very short period of time. It was fear that was driving the change, not business factors.

As further evidence of stock prices being low, companies were buying their own stock. If a business has cash and the value of its stock is low, buying back its own stock improves their balance sheet. It’s a smart business move. If companies believe their stock is selling for a bargain price, then perhaps investors should as well.

Take the Long-Term View

Regardless of what the market did last week or what it will do this week, you need to take a long-term view with your investing. Historically speaking, the stock market outperforms other asset classes over the long-run. This means that if you want and need growth, the stock market is the best investment for you. However, you must only put money in the stock market that can remain invested for at least five years. Money needed in less than five years should be maintained in a fixed income investment such as bonds, certificates of deposit, or savings accounts.

Once you have established the appropriate portfolio for your situation, stay invested. Don’t let your emotions change your direction.

It has been proven that reacting to emotions can have a negative impact on investment returns. During the last twenty years, according to an annual study by Dalbar Inc., the average annual return of an individual investor in the stock market was 4.48%, yet the S&P 500 return over the same period was 11.81%. This means that the average investor underperformed the market index by over 7%. The cause of this missed return, according to Dalbar, is investor behavior.

Bottom line: Long-term investors will fare much better than those who allow emotions to guide their investment decisions.

Summary

Investing isn’t for the faint of heart. You need to set the direction of your portfolio based on your personal objectives. Then, resist the temptation to react to your own emotions or those displayed by others. Focus on the long-term and the stock market will reward your patience.