Down years in financial markets are a test not just for your investment portfolio but for you as an investor. It can feel abstract when your Financial Advisor asks you, in better times, whether you’re comfortable with a 15% or 20% loss in any one year. When a decline actually happens, a lot of investors question their resolve.
What happens next, in many cases, is what’s called a “flight to safety.” As fear sets in, investors often get the urge to sell their growth stocks and buy lower-returning but predictable bonds and guaranteed investment certificates (GICs). One problem with this tactic is that you’re essentially locking in your losses, substituting the kinds of securities that may do well in a recovery for ones that could take a lot longer to get you back to your portfolio’s previous levels.
That’s not to say you should ignore the fear you feel when your portfolio shrinks in value or avoid more conservative investments. Rather, the fear factor might point to a legitimate need to revisit the way your portfolio is constructed and whether your asset allocation matches your risk profile. Ultimately, you want to avoid sudden deviations from your long-term plan.
How can you manage the feelings of taking a flight to safety?
Check your risk profile
Studies in behavioural economics show people react asymmetrically to investment losses and gains. That is, they feel more pain – and are more inclined to take action – after losing funds than after gaining them.1 Unchecked, this loss-aversion bias can have a negative influence on investment returns. It’s what makes people sell out of their investments entirely in a downturn, but it also makes people purchase more conservative investments to stem their losses.
If the market's ups and downs in 2022 caused you discomfort, it may be time to consider your risk profile. While it could make sense to put some of your money into more conservative investments – perhaps money earmarked for a short-term goal needs to be better protected – any hand-wringing may also suggest a need to change your asset mix. If you can create a portfolio that gives you less anxiety, you may not have those flight-to-safety feelings the next time the market declines.
Face your fears
Investment fears are natural, of course. But there are ways to confront them and separate valid concerns from exaggerated ones. You’re probably not worrying about a 15% loss so much as you’re concerned about foregoing the early retirement you hoped for. Or you may worry about working so hard and not having anything to show for it while your peers managed to grow their capital. You can think of feelings like these as passing emotions rather than permanent fears. These emotions have virtually no impact on your income in retirement or, say, your ability to pay for your children’s higher education.
Secondly, try to avoid looking at your accounts or returns every day. A famous study by well-known economist Richard Thaler found that investors are willing to accept more risk when they look at their portfolios less often.2 Another Thaler study found that investors who checked their portfolios quarterly rather than daily lowered the chances of seeing a moderate loss in their portfolio from 25% to 12%,3 reducing that flight-to-safety feeling.
Instead of running for the exit on a moment’s notice, try to commit to diving deep into your portfolio only once or twice a year, examining what asset classes have outgrown their target allocations and which shrunk below comfortable levels.
Walk, don’t flee, to safety
Once you’ve re-analyzed your risk profile you may find the need to decrease your exposure to higher-growth, higher-risk assets. What types of assets to buy depends on a variety of factors, such as your time horizon and short- and long-term goals.
Ultimately, it’s important to understand that most investors have fears – and urges to flee. But history tells us that it’s often better to stick around — a strong recovery is often around the corner.
