What a crazy week it was on the stock exchanges. Huge swings up and down, see-sawing back and forth, massive losses followed by massive gains, unbridled despair followed by unbridled joy, and so on and so forth.
Naturally, when stuff like this happens, people tend to panic. And who can really blame them? After all, isn’t freaking out and doing crazy things usually the most sensible thing to?
Nonetheless, when it comes to investing, panic is rarely your friend. It’s hard enough to make good investing decisions when you’re not under the impression that the world will soon end. But when you are under such an impression, making good investing decisions becomes nearly impossible.
One the other hand, making bad decisions is surprisingly easy. Not only that, making multiple bad decisions which build on one another to result in a really massive screw-up is not that hard either.
And so with that in mind, allow me to present a fun little scenario of making bad decisions in a wild market.
What Not to Do in a Down Market
It’s Sunday, August 7th, 2011. You have a cool $10,000 invested in a Dow Jones index fund. Things were rough the week before and you’re a bit on the edge. Still, you’re trying to stay calm, reassuring yourself that everything is ok. “I have a good feeling about the market”, you murmor under your breath, “things are OK”.
Monday comes fast and furious. In what can only be described as a massive global freakout, the markets go into a vicious downward spiral. All hell breaks loose and the Dow loses 6% of its value. “I knew it was a mistake to stay in!” you think to yourself. “I should’ve gotten out when I had the chance. Well, I’m not making that mistake again. I’m getting out right now!”. With a click of a mouse, you pull your remaining $9,423 out of the market.
On Tuesday, things take an unexpected turn: Dow gains 4%. “Ok, maybe I overreacted,” you say say to yourself. “Maybe I should’ve stayed in, you know, let it ride. Ok, no problem, I’ll buy back in. I have a good feeling about the market. Things are OK.” And with that, you put your $9,423 back in.
Wednesday starts off badly and then quickly gets much worse. The Dow drops again, this time by 5%. “Oh come on!” you exclaim. “You’ve got to be kidding me with this! First, the world ends, then it doesn’t, and now it does again? I need to get out right now!” Another click of a mouse, and your $8,976 is once again under the mattress.“Never again” you promise yourself. “I am not going back in no matter what!”.
On Thursday, another fun surprise: the Dow gains back 4%. “WOW!” you shout at the screen, “WOW, WOW, WOW! I… HOW… WHY?… why?”. Dejected and broken, you put the money back in.
On Friday, the Dow gains another 1%. Your portfolio gains back $100 to end the week at $9,076. You go drinking.
So, to recap: by selling and buying with each wave of panic, your $10K lost just under 10% in one week. As a point of reference, had you done nothing, you would’ve lost 1% or $146. Who said investing wasn’t fun?
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