Oh, we humans and our funny brains. We all hate losing money for all the obvious reasons, but our brains may actually make us fear the loss even more than we should. When it comes to a quickly deflating stock market, our loss-averse brains could lead us to make emotional, fear-based decisions that will lock in those losses permanently. (Is Fear Running Your Investment Strategy?)
Starting 2016 With A…Bust
The stock market came out of the gates in 2016…and promptly fell on its face. Spiraling oil prices and continued shakiness in the Chinese economy have dragged down stock indices around the world. As of the writing of this article, oil is below $30 a barrel, and the Dow Jones is already down 11% on the year with predictions that the free fall is far from over.
For those of us who must watch the dollar signs in our retirement account tick down, down, down, the itch to sell is getting hard to ignore.
Resist the Urge to Make Emotional Decisions
That itch you feel? It’s your brain succumbing to a deep-seeded fear of losing what you have. In economic and decision theory circles, this concept is called loss aversion. Well duh, you might be thinking, no one likes to lose money. Loss aversion may seem obvious, but researchers who study the phenomenon have suggested that we fear loss even more than we value gains. In other words, losing $100 of our hard earned money is more painful than the joy we get in gaining $100.
Think about this concept in relation to investing in the stock market. The purpose of investing is to gain money over time, but we’re also battling our fear of loss. If that fear is greater than our ability to ride out the inevitable rises and especially the falls of the stock market, we are likely to give in and pull our money out near the bottom of the market, thereby permanently locking in our losses.
Beat Your Brain at Its Own Game
Understanding loss aversion theory can help us avoid making fear-based financial decisions. (Learn how Your Female Brain Could Make You a More Savvy Investor.) We all know that the key to retirement investing is time and consistency. For every big drop in the market (On Feb. 1, 2009, the Dow Jones closed at 7,062) there is invariably a recovery (On Feb 1, 2015 the Dow Jones closed 18,132). If you would have cashed out of the stock market on Feb. 1, 2009, you could have lost years of incredible gains before regaining the courage to jump back in. (Sometimes it is the right time to sell. Learn the Six Signs That It’s Time to Sell That Stock.)
That’s why you need to beat your brain at its own game. Instead of looking at the falling stock market and seeing losses, see the truth – stocks are on sale. Your brains hates losing money, but it sure does love getting a good deal! The lower stocks get, the more of them you can afford with your monthly retirement investments.
Of course, your retirement portfolio should also have a balance of safer bets, like bonds, in a proportion that is reasonable for your age. The closer you are to retirement, the less risk you can afford to take in stocks.
We know that the stock market can seem like a scary place right now, but don’t let your fear rule your financial decisions. Learn more about saving for retirement in our retirement article archive