Fear is the second of the two most powerful emotions elicited by the stock market. The other, of course, is greed. Humans tend to exaggerate these emotions when events tigger the onset of either one. In this post, I want to discuss this negative emotion, fear.
Fear of loss (of almost any kind), according to most research, is felt more keenly than its market opposite, greed. Greed is probably more aptly described as overconfidence, with regard to the stock market. Fear is felt more intensely as money is lost, than is the feeling of overconfidence resulting from investment profits. Why is this? Probably because fear, historically, has had greater survival value than a sustained state of overconfidence. When humans have taken appropriate counter measures, throughout history, to alleviate a fear-inducing threat, this has typically result in higher survival rates. Overconfidence, on the other hand, has had the opposite effect, many times resulting in reduced levels of preparedness necessary to meet a mortal threat.
Fear has been called the “fight or flight” emotion. And while it often leads to appropriate decision-making, sometimes it does not, especially with regard to the stock market. The typical fear-based stock market activity involves selling stock, in an attempt to stop the bleeding. What the investor doesn’t understand at this point, is that the bleeding is almost always self-correcting, as time goes on. Of course, this is largely true only if broad-based index funds are what make up the portfolio. If an individual stock is experiencing a free fall, the bleeding may very well end up in the death of the stock (bankruptcy).
This is almost an impossiblity for a stock fund indexed to the S&P500, for example, because the value of an index fund is typically determined by hundreds of different stocks. Will all of them, half , or even a quarter of them bleed to death? Not likely. So the investor is protected against permanent total loss. Please read this paragraph again. If you understand and agree with what it says, you never have to fear a stock market crash or severe correction again. Why? Because the 240 year history of our country proves the stock market always comes back. The investor’s only fear has been that one or more of his stocks may not come back. This possibility is now totally eliminated with index funds.
Why only index funds? What about other managed mutual funds. Many mutual funds have expense ratios which are totally ridiculous, being so high as to have no relation whatsoever with the manager’s performance. These companies engage in this stock market highway robbery because most investors don’t know they are being taken, provimg once again it is very dangerous to be financially illiterate. Year after year many investors put their financial futures at risk by trusting these firms to treat them fairly. As I’ve said many times before, index funds don’t need managers in the usual sense, once they have been funded, except on rare occasions. So why pay over 1% a year, instead of .05% (the expense ratio for Vanguard’s S&P500 index fund)? It makes no sense whatsoever, especially since the performance of “managed” funds, on average, significantly lags index funds in almost every study ever done.
Fear drives and maintains a bear market. And most fear, as I’ve explained is unwarranted. The broadbased selling in a bear market feeds on itself, as more investors sell into the panic. Thus, this fear becomes the bear’s (and bear market’s) best friend. Instead of supporting the market with buy orders to take advantage of funds on sale, most investors believe and act at this time, as if the stock market is never coming back to pre-crash, or severe pre-correction levels.
I actually look forward to a market crash or severe correction, not only to buy more stock, but also to rebalance within the portfolio, selling a bit of the winners, and buying more of the losers. This forces me to sell high and buy low, and is called rebalancing. If you know the market is coming back within a reasonable time (which it has done going back to 1776), then the fear should be gone. Of course, ‘reasonable’ could mean several years or more, although the average bear market, going back more than eighty years, has lasted eighteen months.
So, the best way to control fear is to #1: Understand that the stock market will revive itself on average in a year and a half, #2: you, as an investor, should be buying at this time, not selling., and#3: always have enough money in an emergency fund and also for all expected expenses for at least six months. This money should be separate from your investment portfolio. And remember, if retired, income from treasury inflation protected securities (TIPS), should be sufficient for eight to ten years, and kept separate from stock investments, while at the same time, embarking on an investment program which does include stocks and bonds. This is explained thoroughly in my book, “How To Make a Fortune During Future Stock Market Crashes With Strategic Stock Accumulation”. The book is available on Amazon and Kindle.