Panic Selling and Seven Other Mistakes for 2020
Financial professionals appear to be spot-on in their assessment of investor behavior. Results from our own surveys of individuals in the US, along with industry fund flows, show that when it comes to these mistakes, many investors are guilty as charged. Consider how the evidence stacks up against them.
Whatever you call it, panic selling, making emotional decisions, or focusing on short-term performance, it all adds up to the biggest mistake for investors.
- Panic selling: As market volatility shot up and the S&P 5002 losses reached 34% in March of this year, Strategic Insight reports that investors sold out of mutual fund positions to the tune of $327 billion3 in the US alone, demonstrating that a sell-off is often a knee-jerk reaction to sudden volatility spikes. Not only did those who sold lock in losses, but they also missed out on a 20% rebound in April.
It all hit an emotional hot button for many. Strategic Insight also reports that the perennial safe haven of money market funds took in $1 trillion4 in assets between January and May as investors sought refuge from the pandemic market.
It all adds up to short-term decision making. And while most investors think they are focused on the long term,5 eight out of ten professionals say they are too focused on the short term.
- Market timing: The fight or flight instinct is hard wired into our brains and it kicks in when we see the potential for losing assets in a market downturn. On the flip side, we see a rising market and we can be overcome by FOMO – fear of missing out. Recent history shows that investors lose out when they give in to their timing instincts. In 2018, investors experienced some of the highest levels of volatility in a decade: Their flight instinct cost them dearly. October of 2018 brought the worst of it, and as the S&P 500 returned -6.84% for the month, investors racked up losses of -7.97% for the same month. In August, when the S&P delivered +3.26%, investors gained 1.87% on average.6 Bad timing added up to sub-par performance for many.
- Failing to recognize your own risk tolerance: Sure, everyone thinks they are risk-on, but when the market brings it on, how do you react? 56% of investors say they are willing to take on risk in order to get ahead. But when pushed, more than three-quarters say they really prefer safety over investment performance.5 It’s important to ask yourself where you really stand on risk.
- Unrealistic return expectations: Considering that investors are really risk averse, they often have outrageous return expectations. In 2019, investors said they expected returns of 10.9% above inflation over the long term.5 Professionals say 6.7% above inflation is more realistic. That’s a 63% gap between perception and reality.
- Focused on cost, not value: Investors see that passive investments like index funds are less expensive, but then make bigger assumptions about how they perform.5 Nearly eight in ten professionals say investors are unaware of the risks of passive. To prove them right, 64% of investors think passive is less risky and 71% think passive will protect them on the downside.5 Passive investments have no risk management. They are as risky as the market is, and up or down, they deliver market returns.
- Failing to recognize the euphoria of an up market: Five years ago, the Natixis Center for Investor Insight collaborated with the Massachusetts Institute of Technology in an evaluation of investor behavior. Presented with a scenario where the S&P gained 10% in six months, investors were much more likely to extrapolate continued gains and increase their investment.7 Advisors were contrarians, suggesting that it was actually time to lock in some of the gains by reducing equity allocations.8
- Taking on too much risk in pursuit of yield: With interest rates at all-time lows for more than a decade, investors have been forced to go further afield for yield, and have added more and more risk to their portfolios as a result. Strategic Insight reports that flows into high yield bonds had been negative through the first three months of 2020 – including almost $11 billion in outflows in March alone. But after the Fed cut rates by 150 basis points in March and April, flows into the category rebounded to positive inflows of $10 billion by May 31.9
- Failing to consider the tax implications of investment decisions: Three-quarters of investors may say they consider tax implications when making investment decisions,5 but their behavior in periods of stress may actually trigger unintended taxable events. For example, a big sell-off in your portfolio could lock in gains at a time when markets are declining rapidly. This is why it’s critical to make decisions strategically; even if you want to sell, it’s important to ask which holding should be sold first.
Natixis Investment Managers, 2020 Global Survey of Financial Professionals, conducted by CoreData Research March–April 2020. Survey included 2,700 financial professionals in 16 countries, including 300 in the US.
2 S&P 500® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large-cap segment of the US equities market.
3 Strategic Insight Simfund. Includes open-ended long-term mutual funds. Excludes closed-end funds, ETFs, money market funds, and funds of funds.
4 Strategic Insight Simfund MF.
5 Natixis Investment Managers, Global Survey of Individual Investors conducted by CoreData Research, February–March 2019. Survey included 9,100 investors from 25 countries, including 750 in the US.
6 25th Edition of DALBAR’s Quantitative Analysis of Investor Behavior, March 2019.
7 MIT/Natixis: based on findings from Natixis 2015 Global Survey of Individual Investors, conducted by CoreData Research, February 2015. Survey included 7,000 investors from 17 countries.
8 Natixis Investment Managers, Global Survey of Financial Professionals conducted by CoreData Research, July 2015. Survey included 2,400 financial advisors in 14 countries and territories.
9 Source: Strategic Insight, Simfund MF; Open-End Mutual Funds Only.
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