It is human nature to flee from perceived danger. This is true in investing as much as it is in other situations. When the market goes down precipitously or suddenly, our first instinct is often to sell. This with withdrawal of capital at the worst possible time is also known as “panic selling.” We have written about this phenomenon before and wanted to reprise our words of caution to not over-react during times of turbulence.
Investors, unfortunately, have a poor track record in this regard and have repeatedly demonstrated that they are easily swayed into the herd mentality of selling their assets at the very time those investments are declining. This ultimately usually leads to what we would call a “double loss scenario”. The first loss occurs when we sell the asset at a momentarily distressed price. This results in financial underperformance. The second loss occurs because the investor has taken themselves out of the market, at least for a time being. So they are not able to participate in the almost certain rebound of that investment. While that will be a topic for another day, research since 2000 has shown that there is a 22 point difference in returns if an investor misses the top 10 days of the market (+9.8% versus -12%).*
Because most investors rarely have good insight into what they actually own in their investment portfolios – and why the companies that they own are in their portfolios to begin with – they tend to sell assets while prices are dropping. This has been substantiated by the well-cited Dalbar Study, which has repeatedly documented this negative investor behavior.
The question is why does this occur so frequently?
At Nepsis®, we believe this is due in large part to the fact that many investors own Mutual Funds or ETFs. As a result, they are unaware of the underlying holdings that compose their funds, of which many are sound companies with solid fundamentals. Investors simply focus on the current value of their portfolio as a whole, failing to have knowledge or conviction regarding the companies that they own.
Then, during the midst of a market event, such as a correction, investors succumb to “loss aversion bias” and, without the conviction in the companies that are in their portfolios, make the emotional decision to sell. Investors, because of their naïveté as it pertains to the contents of their portfolios, sell what oftentimes turn out to be perfectly fine businesses at discount prices.
Ultimately, investors often end up regretting their actions as the stock prices of sound companies tend to rise over time. Psychological studies have shown that the emotions created by Losses (money or otherwise) are twice as strong as those emotions garnered by Gains.
So how do investors overcome this powerful bias? In our estimation, it starts with two points of clarity: the knowledge of what you own in your portfolio and the rationale as to why it is in your portfolio to begin with. If investors combine these two important ingredients, they will have the insight and fortitude to weather the short term storm and resist the temptation to sell at the wrong time.
Advisory Services offered through Nepsis, Inc.; An SEC Registered Investment Advisor.
Source: *Carson Investment Research 3/9/25 (2000-2024)