In a Bear Market, Avoid the Typical Cycle of Investor Emotions

Jane Young, CFP, EA

With increasing inflation and interest rates, a decreasing market, and the fear of recession, you may feel nervous about your finances. During a bear market, signified by a 20% drop in the stock market, it is understandable to feel anxiety about your portfolio. However, a significant drop in the market also provides the opportunity to gradually buy stock at a tremendous discount.

Although we try to approach investing from a logical perspective, our emotions can get in the way of sound investment decisions. An effective way to guard against emotionally based decision making is to be aware of the cycle of emotions that investors typically experience as market conditions change.

The cycle of investor emotions begins with a reluctance to invest. As the market starts to improve there is growing optimism followed by excitement as the market continues to rise. As the market reaches its peak, investors feel exuberance and sense of missing out if they do not jump into the market. Unfortunately, investing in stock is counter-intuitive because we are the most optimistic about the market and the economy, at the worst time to buy. The goal of every investor is to buy low and sell high.

To compound this, when the market drops there is a tendency to ignore negative information. As things get worse and the market continues to fall, denial is replaced by fear, desperation, and panic. Eventually the concern about losing money is so great that investors capitulate and sell at the bottom, which is the worst time to sell.

This is followed by despondence, depression, apathy, and indifference. Then the cycle repeats itself as the market rebounds.

This is a cycle of behavior that every investor wants to avoid but our emotions and fear of losing money are enormously powerful. During this bear market, buck the cycle. Stay invested and stick to your financial plan. Rather than succumb to the fear of loss and selling stock, consider buying while prices are low.

If you have money to invest, you have an emergency fund, and cash to cover your short-term liquidity needs, continue or start systematically investing a set amount every month. Systematically investing a set amount every month, also known as dollar cost averaging, allows you to buy more when the market is down and less when it is high, without taking a huge risk.

Maintain a diversified portfolio that supports your tolerance for risk and your investment timeframe. Money needed in the next five years should not be invested in the stock market.

We have no idea what the market will do tomorrow. It is impossible to predict the bottom, but if you wait too long you may miss the opportunity. If you panic and sell when the market is low, you will likely be out of the market when it rebounds which locks in your losses.