You know that feeling when you are home alone at night and then all the sudden you hear a noise? In a split second, you go from a peacefully resting in your bed to panic. You get really quiet, you might even hold your breath as you wait; will there be another sound? Your mind starts running wild as you go through the possibilities of what caused it. Was it the wind, an intruder, a ghost? Maybe you begin to walk through your game plan; what am I going to do if I need to defend myself?
Nine times out of ten, the noise is nothing, yet we still go through this involuntary head trip every time. Like a deer who hears a stick crack in the woods, when we sense something harmful could be afoot, our senses get amplified and we pay more attention. We direct our focus toward assessing the situation and determining whether it’s a real threat. Until we do, we don’t know if we should choose fight or flight or just roll back over and go to sleep.
For many of us, the stock market drop last month was that noise in the dark, empty house. After years of calm and quiet, we started to hear things that raised our awareness. We learned of double-digit drops in stocks both domestic and international. We received monthly statements with negative numbers on them. We heard the news talking more about down markets, interest-rate risks and disappointing corporate earnings. Suddenly, we needed to know what was going on and what it meant. We may have even wondered to ourselves ‘do I need to do something about this?’
Shifting into self-preservation mode is a normal response to things that are threatening, and losing money is one of the scarier prospects we face. Our internal system for identifying and navigating threats is typically reliable thanks to thousands of years of evolution. We’ve seen the same threats enough times and honed our instincts to identify and navigate them successfully. Unfortunately, our ability to recognize and manage financial threats isn’t nearly as sophisticated. We’ve had 30, 50, maybe 100 years of experience in the modern financial system; that’s not nearly enough time for our good instincts to become second nature.
Nascent as our financial instincts might be, we still live in a world full of financial uncertainty that demands a system for soothing our panicked brains. One way we cope is by channeling our flight response and moving away from what is causing us stress. Fear around market volatility is what consistently drives the so-called ‘flight to quality’ into government-backed bonds whenever there is a down period in stocks. It’s what drives us to buy an annuity that comes with downside market protection, and sometimes it’s even what gets us digging some well-placed holes in the backyard for a few new coffee cans of cash.
It’s easy to see the appeal of these solutions when the market is the last place you want to be. If we perceive the stock market to be the source of danger, it stands to reason that something with less market exposure would leave us better off. While it’s true these approaches do often mitigate or remove market risk from the equation, that doesn’t mean we’re in the clear. It might feel like we’ve eliminated our financial risk, but really, we’ve just exchanged one type of risk for another.
Those reliable T. Bills might retain their value, but what we don’t notice is that they underperformed the S&P by 12.5% this century. As we focus on the fact that our annuity didn’t lose money in the down years, we might miss that the insurance company capped our gains significantly during the good years, all while charging us a hefty fee. Even the money in the coffee cans is at risk when we consider the way inflation reduces purchasing power over time. These risks may not seem as terrifying as the thing that goes bump in the night, but that’s exactly what makes these silent killers so dangerous.
The search for safety doesn’t always end by moving into seemingly risk-free investments. Sometimes we cope with uncertain markets by seeking advice from the experts. We may turn to the news, our savviest friend or our financial guru to tell us whether it’s time to panic or make a move. If we don’t have the answers, we want someone who does.
As we grasp around for clarity, our inclination is to gravitate toward people with simple, directive solutions. Think of what we’ve done historically in times of chaos; we favored strong leaders with clear explanations for how to solve our problems. Even when their solutions were outrageous, we followed them because they seemed confident in their ability to keep us safe. The same fear that draws us toward authoritarian leaders, draws us as investors toward those promising certainty in our portfolios.
There is no shortage of people out there offering their opinions about what company, sector or asset class is primed for an advance or retreat. They might have loads of technical knowledge and indicators that defend why their theories are sound. They might jump up and down and draw on chalkboards and practically yell their outlook at us. All these things signal to our brain that these folks believe what they are saying and have the foresight and certainty our unsure minds are craving.
The perception of the messenger as trustworthy can overshadow the fact that their message is merely an opinion. It’s their best guess at what might happen, but under the influence of our self-preservation instinct, we hear their opinions and interpret them as facts. We believe we should follow their advice to get out of the market or buy a few ‘recession-proof’ stocks. Their confidence lends credibility to solutions that seem safe even though they almost always include unseen risk.
As risky as uncertain markets feel, it’s our instincts during uncertain markets that pose the biggest risk. The choices we make might feel safe, but we also need to make sure they are sound.