Investor Psychology

When everyone’s selling, it’s time to hold

Investing is as much about psychology, as it is logic and research. That’s why many top fund managers say the best time to invest is when the markets are shrouded in pessimism.

What do they mean?

Simply this: decades of market research tends to show that investors drive down share prices (creating buying opportunities for others) by selling when the outlook is bleakest, and unfortunately they often do so just as the market is in the process of bottoming and moving higher. Investors who panic and sell at the bottom also miss out on this important investing truth: the markets always head higher.

What if investors ignore the gloomy headlines and stay the course? Would they be further ahead?

Let’s answer that question by looking at economic history and then some specific investment returns. Over a 25-year period, from December 1982 until Dec. 31, 2007 the Canadian market, as represented by the S&P/TSX Composite Index, went through six substantive corrections, but each time it moved on to set new highs. Over the same period the index had an annualized return of 10.9%.

Alternatively, ten thousand dollars invested in the same index on Mar. 25, 1988 was worth $39,827, on Mar. 28, 2008 or an annual return of 7.2%. But if investors sold and missed the best ten performing weeks their returns fell almost in half to $20,992, an annual return of just 3.8%.

The challenge then, says Mackenzie Investment’s Chief Strategist Fred Sturm, is to ignore the doomsayers. Why? Because stocks usually set lows at the halfway point in an economic downturn – a fact that is often overlooked by investors who are still focusing on weak economic news. That’s unfortunate, he says, because about one third of the gains in a bull market come in the early recovery phase, while the broad economy is still suffering. Adds Sturm: “If you are waiting for the recession kinds of headline to go away, it will be too late.”

That brings us back to investor psychology. For example, two other market indicators: market sentiment and consumer confidence are bullish – precisely because they are so bearish. Sturm points out that investment letter writers haven’t been this negative since 1994 or 2002/2003 when the market started to turn higher. At same time the US Consumer Confidence Index is extremely low, and 96% of the time when consumer confidence crashes, the S&P 500 posts an average gain of 19% over the following 24 months. And that is a gain worth holding on for.

Check out Mackenzie’s guide on Investor Psychology.