When markets are volatile, many investors find the same questions running through their minds. It seems like the market will keep going down; should I still be investing in stocks? Can I really trust my investment plan to help me reach my goals? Wouldn't my assets be better off in something safer, like cash?
It's understandable that many investors feel anxious about turbulent markets, says Melissa Knoll, vice president of behavioral science at Fidelity, even if they acknowledge that dips are likely temporary. As humans, we are hyper-focused on avoiding, a phenomenon known as negativity bias. The tendency to focus on negative aspects of a situation may be hardwired.
Your brain and market volatility
Since most of us aren't experts at managing money, our decisions around investing may be guided by some biases. However, when markets are volatile, your innate reactions may encourage you to sit on the sidelines or even cash out altogether—causing you to potentially miss out on opportunities or undermine your portfolio's long-term growth potential.
Below are 3 common factors that may contribute to struggles to stay invested—and how to notice your own biases and emotional triggers, helping you make decisions guided by long-term plans, not short-term anxiety.
1. We dislike losses more than we enjoy gains
Finding or losing $10 should make us equally happy or sad. Yet, studies exploring a phenomenon called "loss aversion" demonstrate that losses hurt more than equivalent gains make you feel good.1
When it comes to your investments, the pain of any losses over the past year can overshadow your appreciation for the strong market performance seen over the past decade. "If you're checking your portfolio frequently, you may be experiencing myopic loss aversion, where seeing loss after loss compounds your negative feelings and takes away from the positive feeling of the gains," says Young.
Loss aversion has also been used to help explain the "disposition effect," which describes a tendency for investors to hold onto investments that have lost money and sell those that have increased in value.2 The idea is that we don't want to accept the fact we have lost money on an investment, which tends to make us want to hold onto it even when we shouldn't.
2. Uncertainty is uncomfortable
Hypothetically, if you were offered a choice between an envelope you knew contained $50, and another that may or may not contain $100, which would you choose? Most people tend to opt for the sure thing, because of our natural tendency to avoid ambiguity.3 "Risks that feel more certain or known feel better than risks that are unknown," Knoll explains.
Most investors know it's important to take on some level of risk in order to potentially enhance their long-term returns. However, when markets are turbulent, our tendency to back away from uncertain situations can often prevail. "Right now the market feels extra ambiguous to some, so cash seems like the more reassuring option," says Knoll. "Some people are more comfortable choosing an option when they know what they're getting, even if their long-term gains will likely be smaller."
3. We value today's dollars more than future dollars
We tend to make choices based on a phenomenon known as "present bias," which leads us to overweigh the importance of our current state compared to a future one. "We value dollars today more than in the future," Knoll says. For example, in an older study, people were asked: Would you rather have $700 today—or $1000 a year from now? The majority of people opted for the immediate payout, even though it meant they would be forfeiting a 30% return on the money.4 However, thanks to compound interest and potential returns on our investments, dollars in the future may very well be worth more the present.
Present bias creates a tendency for us to "live for today" instead of sticking to a disciplined route that might benefit our future. For example, if choosing between a brownie and an apple for dessert, we tend to pick the choice that makes our current self happy (the brownie) instead of keeping our future self healthy (the apple). When it comes to money decisions, present bias makes it more tempting to spend our earnings and enjoy money today, and harder for us to save and invest for the future. "Sticking to an investing plan is already naturally hard for us—and when markets are volatile, it gets even harder," says Knoll.
Recognize your emotions and decision biases
It can be hard—but not impossible—to regulate your feelings around investing. The first step: recognizing how your investing decisions are informed by your biases.
Once you're more self aware, consider these tips:
Look less frequently. Research has found that investors who check their portfolios frequently are less willing to accept risk, and over the long run may reduce their returns. 5
Consider sources of safety. You may rest easier knowing some of your assets are protected from stock market risk—including emergency savings and foundational estate planning pieces, such as life and disability insurance.
Don't do it alone. Automatic investing, such as with a 401(k), can help with investing on a regular cadence, no matter what's happening in the market. You can also consider a professionally managed account, which can help you stick to a disciplined process of investing and maintain a diversified portfolio of investments.