Market Crash Investing For Dummies

Investing in the stock market is as much a test of emotional resilience as it is of financial acumen. Understanding the psychological whirlwind investors face during market downturns is key to navigating these turbulent periods with your wealth—and sanity—intact.

Here’s what I’ve learnt over my career about human behaviour when markets are volatile and/or take a nosedive.

All About the Now: During market crises, investors often lose their long-term perspective, focusing instead on the immediate turmoil. This shift towards short-term thinking can derail long-term investment strategies as we seek to remove the anxiety we are feeling right now. It’s crucial to remind ourselves of our initial goals and resist the urge to make impulsive decisions based on short-term market movements.

Tunnel Vision: As markets tumble, our concerns narrow, often fixating on the fall itself rather than broader, more significant factors that affect long-term wealth creation. This tunnel vision can lead us to overlook opportunities for growth that market downturns often present. Keeping a broad perspective helps balance our viewpoints, ensuring we don’t miss out on potential investments that align with our long-term objectives. Crashes offer the opportunities to acquire coveted assets at a discounted price.

“A market downturn doesn’t bother us. It is an opportunity to increase our ownership of great companies with great management at good prices.” – Warren Buffett

Do Something: There’s a strong impulse during market downturns to ‘do something’—any action feels better than inaction. However, this urge often leads to hasty decisions that contradict our investment strategy. Recognizing this impulse allows us to critically assess whether our actions are driven by panic or strategic thinking. It feels like everything is changing, so our investments must also change. We never let our failure to predict what has just happened stop us predicting what will happen next.

I Knew That Would Happen: Post-crisis, many experts claim to have foreseen the event, leading to a surge in hindsight bias. This phenomenon can erode our confidence in decision-making. Accepting that market movements are unpredictable helps maintain confidence in our investment strategies, despite not being able to foresee every downturn. While everyone is busy discussing what transpired, it is worth reflecting on why nobody expected it.

Same Story, Different Day: The notion that markets become ‘more uncertain’ during downturns is a misconception. Uncertainty is a constant in markets; it’s our awareness of it that fluctuates. Embracing uncertainty as an inherent part of investing can improve our resilience against the emotional stress of market fluctuations.

“You make most of your money in a bear market, you just don’t realize it at the time.” – Shelby Cullom Davis

Market Timing: Predicting market movements, especially those triggered by unforeseeable events like a pandemic, is nearly impossible. This unpredictability underscores the limitations of short-term market forecasting. Focusing on long-term trends and fundamentals, rather than attempting to predict the next market move, is a more reliable strategy. Our risk models are often shaped by past experiences, leaving us vulnerable to unexpected events. Recognizing the limits of our ability to anticipate risks can lead to more robust investment strategies that account for unforeseen events.

Black or White: Investors tend to swing between ignoring risks entirely and overestimating them. This all-or-nothing approach can lead to missed opportunities or unnecessary panic. A balanced view of risk, informed by a thorough analysis rather than emotional reaction, is essential.

Salient Risks: We often prioritize risks that have recently occurred or those that evoke a strong emotional response. This can skew our risk assessment, leading us to overprepare for some risks while ignoring others. Now that we have become aware of the types of risk caused by a global pandemic, they will be at the forefront of our thinking and decision making – we will model and plan for them. Unfortunately, we can’t do that for whatever will cause the next market crash. Risk, after all, is what we don’t know.   

“Predicting a downturn is not critical. The important thing is what you do when a significant downturn happens.” – Naved Abdali

In conclusion, navigating stock market downturns requires a deep understanding of our emotional responses and a disciplined approach to investment. By acknowledging these psychological traps and applying a measured, long-term perspective to our investment decisions, we can weather market volatility and emerge with our investment goals and mental well-being intact.

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