As an Investor, How Should You React When There’s a Crisis?
"There's a crisis in Japan!" wrote one of our customers last week, kindly alerting us to the news. We've been watching the very sad and moving images, too, and watching markets react to the devastation. When disasters happen, markets tend to retreat. Our advice to our customers is to 'stay the course' and not let this disaster change your investment plan or asset allocation.
There are several explanations for why markets retreat in the aftermath of disasters. One rational explanation is that the destruction causes reduced expectations for growth – which means stock prices fall. A more emotionally-based explanation is that people are afraid – the disaster is a reminder that there are unknown risks in the world – which causes people to sell off their investments and prices to fall.
When strong emotions like fear are involved, they tend to amplify our actions. That amplification is why, markets crash; when they fall, they fall fast. Markets – like people – often overreact. At times like this, we recommend caution, and ‘staying the course.’
xkcd.com posted a great infographic about the levels of radiation around the Fukushima reactor. Despite all the danger and possibility of even worse things happening, the actual excess radiation exposure has only been about 1/3 of the average daily exposure of an average person. It’s quite possible that markets overreacted.
There is always risk in investing. Prices go up and down. We should be in touch with emotional drivers in markets, and we should avoid reacting emotionally.
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