I had made the remark a few months ago on the radio that investors were going to react very negatively to any type of decline in the stock market. After all, it has been a long time since we have had a normal decline in the market. Thus, any decline is going to feel much worst. Apparantly, that is an understatement.
Investors sold more equity/stock mutual funds the week leading up to August 25th than any other time since the data has been gathered. Now, think about that for a second. Investors sold more than any other time during the financial crisis when the market was down at one point over -50%. The market was down a little over -10% and this is how investors react?
This shows two troubling new developing trends.
First, investors are making decisions through emotional filters rather than logical filters. I am not saying it is a good or bad idea to get out of the market. It can be a good Plan B. However, it is a dangerous precedent to start selling every time there is volatility. That is the absolute wrong way to go about investing and a habit that will insure you will probably not reach your goals.
Second, once you go to cash it is tough to get back in. I don’t have any statistical evidence to back this up. However, I have witnessed this many times over the past 23 years. When investors cash out, it will be years if ever before they get back into the market. There is something about getting out of the market that makes it that much harder to get back in. Of course, this could have a huge negative effect on future retirement plans. Enough people abandon the stock market and this has generational effects on retirement.
There are two remedies to the downsides of getting out of the market. First, make a logical and not emotional decision. Second, have a game plan pre-established ahead of time that gets you back in the market realizing that it might be tough to do.