Investors' Biggest Enemy Could Be Their Natural Instincts
DAVID GREENE, HOST:
As much as we might want to trust our instincts, this period of wild ups and downs on the stock market may not be the right time to do that. The Dow industrials fell a thousand points at the open on Monday. Yesterday, the Dow shot back up, only to fall back down again. Now, we know getting panicky and selling after stocks have already nosedived is a pretty lousy investment strategy, but investors do it anyway. And in fact, our brains send us all kinds of bad impulses when it comes to investing. Here's NPR's Chris Arnold.
CHRIS ARNOLD, BYLINE: Here's the scene - an investment adviser's office in Boulder, Colo. Trent Porter is sitting at his desk. Stocks are crashing. Pundits on TV say it could get worse. Porter's phone rings, and it's a client.
TRENT PORTER: Answer the phone and you could instantly hear the fear in his voice.
ARNOLD: The client works in the oil and gas industry, and he's worried about his job there. And now on top of that, stocks are falling, too.
PORTER: When somebody tells you that their job is in jeopardy and they feel that their retirement account is going to go up in flames at the same time, it's a lot of panic. And you have to do a lot of talking down from the edge when that happens. I told him the only time that you get hurt in the stock market - it's like a roller coaster - the only time you get hurt is when you get out.
ARNOLD: In other words, you don't want to jump off the roller coaster while it's plummeting towards the ground. You want to hang in there and ride the market back up when it eventually recovers. But OK, most of us don't jump off roller coasters when we get scared. So why do we sell stocks?
PORTER: He's been watching CNBC all morning. And his exact words were, we have to stop the bleeding. And by that, of course, he meant get out of stocks.
ARNOLD: We have to stop the bleeding. Brigitte Madrian is a behavioral economist at Harvard.
BRIGITTE MADRIAN: When people watch the market fall, they have a visceral sense in which they experience the loss. There's a term in the economics in psychology literature called loss aversion. And the idea is that people experience a loss twice as severely as they experience a gain on the upside.
ARNOLD: This aversion to loss can cloud our rational decision-making. We want the pain to stop, so we want to sell stocks even if a financial adviser has already warned us that stocks go down and they go up and to just sit tight. And there's also something else going on here. Justin Wolfers is an economist at the University of Michigan. He says if we see stocks fall for one, two, three days in a row, we start to see a trend.
JUSTIN WOLFERS: Our minds are programmed to try and find order where there's chaos, see any way we can make sense of the world around us.
ARNOLD: And so I guess back in the hunter-gatherer days, we noticed that deer tended to walk along this particular path, and that might be a good place to hunt them. And that served us really well seeing that pattern, right?
WOLFERS: Absolutely. You know, if deer always walked along a particular path, then you know where to go hunting. So you want to see order in that chaos. The difference with financial markets is in a financial market, randomness may be the norm, even if in much of the rest of our lives, order and predictability is the norm.
ARNOLD: In other words, you really have no idea whether stocks are going to go up or down tomorrow. Finally, when we worry about our investments, we tend to focus on the wrong things, like stock market corrections. But the financial adviser, Trent Porter, says other things cost us much more dearly over time, for example, paying fees that are too high.
PORTER: What kills you is the slow bleeding of fees, not saving enough and not being properly diversified. I compare it to the difference of an unhealthy diet versus being afraid of a plane crash. The things that you see on the news and that you're afraid of are not the things that get you.
ARNOLD: Some economists who study investing say if you're paying more than half of 1 percent in fees total, you're probably paying too much. And over a lifetime of investing, that can do a lot more damage than a routine stock market correction. Chris Arnold, NPR News. Transcript provided by NPR, Copyright NPR.