You can handle a crash better than you think
Stop worrying and stay invested. Research shows that fear of a loss feels worse than the actual loss itself.
(Money Magazine) -- Have you ever been snoozing on an airplane and been jolted awake by a crunch of turbulence? Your heart pounds, you clutch the arms of your seat, and you jump when the captain comes on the p.a.
That's what the stock market has felt like lately. After a 19% gain in 2006 lulled us to sleep, the Dow Jones industrial average dropped 416 points on Feb. 27 and another 243 on March 13.
It's at times like these that your own behavior feels hard to forecast because everything seems uncertain. What if you sit tight and the market drops further? What if you bail out and the market goes up?
If this is how you feel, you're not alone. But you have less to fear than you think.
Research shows that the regrets you expect tend to be more painful than the ones you experience.
And doing nothing - exactly what you should do when the market falls - will leave you feeling better than selling in a panic.
The Investing Immune System
A team of psychologists led by Timothy Wilson of the University of Virginia and Daniel Gilbert of Harvard recently had people take a simple gamble: Each person got $5, then faced a coin toss. Those who called it right won another $5; those who got it wrong lost $3 out of the original $5.
Before the coin flip, the gamblers predicted how they would feel about the outcome immediately afterward and 10 minutes later. After the coin toss, they rated their feelings again.
Participants predicted that winning would make them happy and that losing would make them miserable - and that both moods would stick. The winners turned out to be right. But the losers were nowhere near as glum as they had forecast; they rationalized missing out on the $5 gain by focusing on the $2 they still had left.
What Wilson and Gilbert call the "psychological immune system" makes us imagine that negative events will feel worse than they actually do. It's a useful defense that keeps us from taking wild risks. But it can make us jittery investors.
What to Expect When You're Experiencing
None of this means that market dives don't hurt. But it does mean that the hurt you'll feel soon after won't be so bad. That's provided you don't sell at the first pang you feel.
Doing so, in fact, will quickly make you feel worse. Studies show that you are much more likely to regret an act of commission (something you did that you shouldn't have) than an act of omission (something you did not do that you should have).
In the short run, you'll kick yourself harder for taking a rash action than for doing nothing.
And in the long run, you'll get over it. Dozens of studies have shown that we are more resilient than we realize; we adapt surprisingly quickly to setbacks ranging from divorce or job loss to paralysis or the death of a loved one.
So how do you minimize your future regrets? Impose rules on yourself now and stick to them.
STAY WITH STOCKS. Your panic in a decline is likely to pass soon, so set a target for how much of your portfolio you want in stocks and stick to it. If you're below that, buy more until you get there.
WAIT FOR THE BELL. If the market is open, your portfolio should be closed. Later you can be more objective.
KEEP A DIARY. Track your portfolio, and your feelings, in a journal. The last time you panicked, how did the market do over the next year? If you were happy when stocks were priced higher than today, shouldn't you be happier now that they are cheaper to buy?
TUNE OUT THE NEWS. Buzzing red stock tickers and words like "crash" trigger your brain's alarm system, making you expect more declines.
LOOK IN THE MIRROR. Stare at yourself in a mirror literally as you think about the market going down. If you see real panic in your eyes, maybe you should sell. Otherwise, you can handle it, and you should.
From the May 1, 2007 issue