Investor Reaction to Market Downturns is Important
Market downturns and market correction; so, what are they and how do different types of investors fare and come out during these times when you’re looking back at historical performance? First, stock market corrections; they’re an inevitable and frustrating part of any long-term investment journey. How you react to them is really the only thing you control because these things will happen but how you react is what you control and that’s going to greatly affect your investment results.
What is a Correction?
A stock market correction itself whether you’re talking about the market as a whole or talking about a sector or an asset class, whatever it might be, from a recent high something triggers a correction of a decline of 10% or more. Typically, corrections don’t last that long, they are maybe several weeks maybe a couple of months but they’re relatively short-lived and anything longer than that starts to stretch out and possibly become something like a bear market.
3 Types of Investors
Three types of investors that we’re going to look at. We’re going to see typically what’s their psychological profile and then if we were to take these three types of investors and apply a hypothetical situation to a past market event how would each come out?
First, the intimidated investor this is the person who’s just locked into the screens, locked into the news during these market downturns and corrections and they just can’t escape it mentally. They get so overwhelmed and so emotionally involved in the process that they end up making decisions based on those emotions which are never a good idea.
Second type of investor is the patient investor this person probably does the opposite. They’re not paying much attention to the day-to-day news during the market downturns or corrections because they’ve got their eye on a future event meaning that near-term and interim term, it’s only having those effects. Long term they still understand their plan of action where they’re trying to get to and what they need to do so they mostly ignore the noise.
The third type of investor is one that I call the intelligent investor. This is somebody who makes data-driven decisions based on the current environment. They’re still looking at different types of sectors or assets or individual companies and they’re identifying when they believe that a good company or a good asset goes on sale and then they’re making additional moves with additional capital.
Grading Each on Hypothetical Situation
There are steps to becoming a better investor and that’s really from learning from past cycles so you can try to forecast future cycles. When we look at for example at each one of these investors; the intimidated investor, the patient investor, and the intelligent investor during a market downturn to see how each would react and let’s see what type of a grade each would get coming out of that time.
We are going to illustrate those hypothetical investors that we’ve already talked about who each invested $10,000 at the market highs prior to the 2008 market downturn. We got $10K being invested by each one of these types of investors now we’re going to look at March 2009 as a decision point and then we’re going to look at the outcome as of December 31st, 2021.
The intimidated investor took that $10k and following that 2008 market downturn they sold all their stocks, and they just went to the sidelines with cash starting in March 2009. The ending value as of December 31st, $5087. Obviously not the right move.
The patient investor they did absolutely nothing they just held stocks through the market downturn and throughout that period leading into the end of 2021 they would have an ending value of $40,812. So, in this case it paid to be patient.
Then last is the intelligent investor. They viewed 2008 downturn as an opportunity to buy stocks at lower prices, sale prices, so they put additional capital to work investing another $10k in stocks in March of 2009 which creates a total portfolio value in this hypothetical situation looking backwards of a $132,031 as of December 31st, 2021. In this case it really paid to be an intelligent investor.
You can see by the psychological nature of how these people operated and made their decisions what happened and obviously being driven by emotions is a bad thing, getting paid to be patient is a good thing and being paid even more to see things through as an intelligent investor is the best position to be in.
Past performance is a great way to try to look into the future and figure out what typically can happen; however, full disclaimer past performance is no guarantee of future performance and everything we’ve discussed in this article is just for educational purposes to teach you about market corrections so that you can hopefully make better decisions during those periods of time. Market corrections are going to come and they’re going to go but overall, when you look at your portfolio and your goals if you’re a long-term investor when faced with market corrections you can’t act emotionally and you can’t just abandon your investment plan. Be patient and assuming your goals and your time horizon have not changed, view the downturn as an opportunity to purchase good businesses at attractive prices.