Falling stock markets are not easy to handle. It’s painful to see your portfolio in the red with the value of your investments shrinking by the day. And, we are in such a market at the moment with the Straits Times Index (SGX: ^STI) down by 25% to 2,645 from a 52-week high of 3,550 that was reached in April, though the last two trading sessions – when the index gained 2.7% and 1.4% – have provided some welcome respite. It’s worth remembering that market crashes are a feature of the market, not a bug, and that lasting wealth…
Falling stock markets are not easy to handle. It’s painful to see your portfolio in the red with the value of your investments shrinking by the day.
And, we are in such a market at the moment with the Straits Times Index (SGX: ^STI) down by 25% to 2,645 from a 52-week high of 3,550 that was reached in April, though the last two trading sessions – when the index gained 2.7% and 1.4% – have provided some welcome respite.
It’s worth remembering that market crashes are a feature of the market, not a bug, and that lasting wealth and strong gains have been built in the market despite having stocks fall hard time and again.
But even if some investors have internalized the message just above, the experience of having to sit through bear markets (and I’m using “bear” here loosely to mean “stocks that have fallen hard”) can still be unbearable. If you belong to this camp, I’ve good news for you: There’s a way to make a falling stock market less painful to your psyche.
It’s shown in the following passage from the book Misbehaving: The Making of Behavioral Economics by economics professor, Richard Thaler (emphases mine):
“The paper reports an experiment in which student subjects at Berkeley were given the job of investing the money of a portfolio manager for a university endowment. Of course, they were only pretending to be portfolio managers, but the amount of money they earned in the experiment did depend on how their investments turned out. Their earnings varied from $5 to $35 in less than an hour, so it was real enough for them.
As in the previous experiment, the subjects had only two investment options, a riskier one with higher returns and a safer one with lower returns. In this case, what we varied was how often the subjects got to look at the results of their decisions.
Some subjects saw their results eight times per simulated calendar year of results, while others only saw their results once a year or once every five years. As predicted by myopic loss aversion, those who saw their results more often were more cautious. Those who saw their results eight times a year only put 41% of their money into stocks, while those who saw the results just once a year invested 70% in stocks.”
Did you catch that? What Thaler has shown is that the key to making a falling market more bearable is to simply cut the frequency at which you check your portfolio. Frequent checking hurts because of (1) the loss aversion bias that we humans tend to exhibit whereby losses feel more painful than gains even when they’re of the same magnitude, and (2) the stock market’s penchant for clocking daily losses very frequently.
It’s worth noting that this behaviour of the market applies even to massive long-term winners. Straco Corporation Ltd (SGX: S85) and Riverstone Holdings Limited (SGX: AP4) are great examples. From the start of 2007 to today, they have seen their share prices climb by 575% and 500%, respectively. But, take a look at the table below, which shows how frequently a trading day with a gain or a trading day with a loss has appeared for each company since the start of 2007:
What’s striking is how close the frequencies of days-with-a-gain and days-with-a-loss are for both companies. Keep in mind that this happened during a period when the two shares have increased by six-fold or more.
This is not a call for investors to hide their heads in the sand when a bear market hits. Instead, it’s a reminder that checking one’s portfolio often not only serves no purpose, it could even be harmful investing behaviour during adverse market conditions. When the market falls, a much better use of time, in my opinion, would be to study the underlying businesses of the stocks that you’re interested in or already own.
When there’s a big divergence between a stock’s price movement and the progress of its business, that’s when fortunes can be made.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Straco Corporation.