Many studies of investing over the years have concluded that humans may not be wired properly for investing. Many human survival behaviors that are good for us-like not touching a hot stove-carry over to our behavior surrounding our investments.
Jason Zweig of the Wall Street Journal recently wrote about this topic and the research done by Robert Shiller, the Yale University economist who shared the Nobel Prize in economics in 2013. Some of Shiller’s research in this area showed that investors are more likely to believe a market crash is coming if a recent sharp drop in prices was prominently covered in the media. Even professional investors can get caught up in this behavior in spite of their experience and knowledge. Zweig offers the plausible explanation that negative events sear themselves into the human mind more that positive ones.
At the bottom of the bear market in March 2009 more than four out of five institutional and individual investors thought there was a strong chance for a market crash, despite the fall of over 50% in the prior two years, according to the Yale study. Naturally, they were wrong and stocks have more than tripled in the 10 years since.
In today’s 24-hour news cycle, investors are constantly inundated with information and explanations of that information. Investors crave explanations after sudden moves in stock prices. But sudden moves should be expected if markets are working. Since 1896, the Dow Jones Industrial Average has fallen at least 2% in a single day 1,011 times according to Mr. Zweig. That’s about once every 6 weeks. So, when the Dow occasionally falls or gains 5-600 points in a day, investors only reaction should be, “Well, I expected that”.