As of the day of writing the S&P 500 Index has dropped 5.43 per cent over the past month.
Every second news bulletin we open references Covid-19 and the first person to have a repeat diagnosis of the virus outside of China has just been identified.
Recommendations that mass gatherings should be postponed are being adhered to and the number of cases being identified in China is reducing with the focus moving more towards Europe, in particular Italy.
The investor’s reality When markets get jumpy as they are now, retail investors tend to get shy and generally keep their powder dry rather than buying stock at a 5 per cent reduction to what they would have paid last month.
The reason why they are holding back is that they are concerned that prices may fall further, and they will regret not having the money to invest at an even cheaper price in the future. Not only that, but whatever money they have in their investments is also falling so their confidence is also being hit on that side.
Two years ago, I did a piece on what is known as the “Market Emotions Cycle” which refers to how many retail investors react emotionally to rising and falling markets. It essentially describes how people tend to buy and sell risk assets the wrong way around i.e., they buy at the peaks and we sell in the dips maximising potential losses during the investment cycle.
At the present time a 5 per cent slip in valuations is not going to create too much hardship or concern for people, particularly given current circumstances.
Indeed if you ask an investor how they would react if we had a longer-term and deeper fall in valuations they will generally tell you that they will hang on until things improve and come back up, but the question is ‘will they’?
The market emotions cycle holds that when prices fall over a longer period into a deep trough, capitulation sets in eventually and the sell-off begins at the wrong time.
Behavioural economist George Lowenstein refers to what he calls the hot-cold empathy gap.
This essence of the idea is that humans are “state dependant” meaning it is hard for us to imagine how we will feel in a state contrary to the one we are in presently.
When people are sad it is hard to imagine accurately how they would feel in a happy state and vice versa.
The same applies to investors who become lulled into a cold complacency when markets are calm, but when a period of volatility arises, they enter a hot emotional state which has a significant impact on their decisions.
Strategies on when to sell or buy should be made in the planning stage and held fast during hot emotional periods to avoid poor decision-making.
Many professional investors recommend that you consider your mood before you decide, also that investors minimise how often they look at the value of their funds.
I have also previously written about monthly cost averaging and particularly during times of volatility, this comes into its own. It is always very difficult to invest in markets when they are at their lowest point.
Firstly we never know when that is until hindsight tells us and secondly from experience when markets are at their lowest point in a bear run it is normally the most frightening point in the cycle meaning you would need to be very brave to invest.
To put it in context, €100 invested every month for 40 years growing at 5 per cent on average would be worth €155,000 at the end of it.
Successful pension saver One of the most successful pension savers I have come across was a client who on presenting to our office for the first time, told me she had had a pension for years but that it was useless.
She was in her early 40s and had started putting €500 away on a monthly basis when she was 25.
Each year the payment amount was increasing by a small percentage, possibly causing her some annoyance and apathy.
Having discussed the issue, we decided it best to do some research and find out just how useless this annoying pension savings plan was.
Much to all our surprise a few days later the response came back that there was, in fact, €1.2m in the fund.
She had never looked, just kept paying her premiums. I would not advise completely ignoring one’s funds but there is a lesson in holding steady and not being driven by the rollercoaster of news cycles.