Fear is an incredibly powerful emotion that often serves humans well when it comes to survival. But in the stock market, acting on fear can be dangerous, something Chuck Jaffe notes in a recent MarketWatch column.
Jaffe highlights two recent studies showing how risk-averse investors are, even with the market teaching high after high. One found that Americans on average have nearly half of their portfolios in cash, and less than 20% in stocks.
“The … problem is that investors are looking for portfolios that are devoid of risk, as if such a thing actually exists,” he says. “It doesn’t. Put your money in the mattress and you have completely avoided stock market risk, the chance that your principal will be lost, but you have embraced purchasing-power risk, the potential for your money to fail to keep pace with inflation over time. (In your mattress, you also would have risks about how a fire, theft or other calamity might threaten your nest egg.)”
Jaffe says “It works that way for virtually every type of risk, where you can avoid each hazard only by exposing yourself to another one.” He stresses the importance of having a plan in combatting fear. “If you don’t ‘take your shots’ because you are taking a calculated risk and believe your portfolio will benefit long-term by waiting until later to try to score, then you have a strategy,” he says. “But if you are not taking shots because you are still scared about events now more than five years into the rearview mirror, you need to recognize how that is going to affect your ultimate score. You’re kidding yourself when you think that kind of strategy — even if it holds you steady — is not ‘losing.'”