Why is it that when we are told our dinner plate is hot and not to touch it, we inevitably touch it and get burned? This sentiment also applies in the wake of economic disruptions and we are told not to panic. Then what happens? Inevitably, people start to panic.
Psychology and Investing
Psychology also holds true when it comes to investing. When we are saving in our employer’s 401(k) plan and have years and decades until we retire, why do we fall prey to trying to guess the market and change our investment elections?
Intellectually, we realize that the stock market will have ups and downs year-to-year with the understanding that over the long-term history has indicated the positive upward bias of the stock market. It is noteworthy that many 401(k) plan savers did not realize that bonds can indeed have negative returns. If they did not realize that bond prices move inversely with interest rates, they sure learned it in 2022, when the Federal Reserve raised the discount rate.
Strategic Risk Taking
In order to achieve a long-term rate of return over the rate of inflation, investors have to take some risks. Consider that when someone enrolls in their employer’s 401(k) Plan, they get a plethora of information relating to the various investment options including descriptions, performance, and other characteristics.
There are a variety of charts, graphs, and tools available to depict different accumulation scenarios. These scenarios are based on various assumptions, with the fundamental belief that diversification and a long-term investment approach help to minimize the effects of short-term negative returns (also known as volatility). It is essential to remember that "no one can time the market over the long term," therefore, it is futile to spend time and energy trying to do so.
With all that being said, when there are financial events that capture the headlines like the Silicon Valley Bank bailout and the resulting ripples, why do long-term savers often panic? Perhaps reviewing the definition of panic helps us to better understand why.
Used as a noun or a verb, panic is described as a sudden wave of uncontrollable fear/anxiety, often resulting in impulsive behavior. “The crowd panicked and stampeded for the exit–used as a verb, this sentence probably hits the nail on the head as it relates to the psychological action of “following the herd."
One of the best examples can be seen in Joseph Conrad’s great book, Lord Jim, (spoiler alert!) when the protagonist, Jim, jumps into the lifeboat–knowing he should not–as the rest of the crew believes the ship is sinking and they abandon the passengers. He spends the rest of his time regretting the rashness of his decision because he panicked and followed the actions of others.
So what should a concerned 401(k) Plan saver, or investor, do? It is a good idea to review the big picture focusing on their investment allocations like their time horizon and appropriate level of risk to accomplish their long-term financial goals. They should keep top of mind that trying to surf the volatile waves of the economy can result in a wipeout and lost future investment gains.
Lastly, remember that people often get on TV because of the provocative things they say and not what they actually believe!
Want to know more about how to stay ahead of the panic? Contact Dave Evans, Director of Institutional Sales.