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  • Writer's pictureDoug Lagerstrom

Fear | Psychological Effects on Investors

Over the past four months investors have faced runaway inflation and war in Ukraine. Needless to say, the stock market has been volatile lately and clearly investors are afraid. Is this a problem?

We have nothing to fear, except fear itself. The words or sentiment is primarily attributed to Franklin D. Roosevelt at his first inauguration in 1933. You may recall that our country was mired in the great depression at the time. However, perhaps this sentiment is more timeless than previously thought. In the 16th century, Michel De Montangue wrote, “The thing in the world I am most afraid of is fear….” In the 17th century, Francis Bacon added his twist on the sentiment by writing “Nothing is terrible, except fear itself.” In 1851 Henry David Thoreau wrote, “Nothing is so much to be feared as fear.”

What is it about fear, and overcoming it, that has our attention?

According to Northwestern Medicine, “Fear is experienced in your mind, but it triggers a strong physical reaction in your body. As soon as you recognize fear, your amygdala (small organ in the middle of your brain) goes to work. It alerts your nervous system, which sets your body’s fear response into motion. Stress hormones like cortisol and adrenaline are released. Your blood pressure and heart rate increase. You start breathing faster. Even your blood flow changes — blood actually flows away from your heart and into your limbs, making it easier for you to start throwing punches, or run for your life. Your body is preparing for fight-or-flight.”

It’s no wonder that the stock market takes the stairs on the way up (as investors gradually get comfortable with investing), but the elevator on the way down (as traders rush for the exits).

The irony is we know it is wise to buy when others are selling. This is reflected in the numbers. According to Ned Davis Research there have been more than 50 crisis events since 1900. They found that after falling an average of 7% immediately after a crisis, the Dow rose 4.2% over the next three weeks. Nine weeks later it had gained 6% and after 18 weeks it was up an average of 9.6%. According to Barron’s the study “shows remarkable symmetry in market reaction.” Other studies have shown that after bear market declines or 20% or more the NASDAQ has averaged a six-month return of 10% and been in positive territory nearly two-thirds of the time going back to 1972.*

So why can’t more investors buy when the stock market goes down? Fear, it seems, prevents them from making this logical decision. “As some parts of your brain are revving up, others are shutting down. When the amygdala senses fear, the cerebral cortex (area of the brain that harnesses reasoning and judgment) becomes impaired — so now it’s difficult to make good decisions or think clearly.” (Northwestern Medicine)

We believe the key to managing volatility is to have a plan before the stock market declines significantly. By agreeing to increase your risk profile when the market declines, you’re able to use logic and not respond to fear. Fear, like risk, cannot be eliminated, but it can be managed.

Doug Lagerstrom

1. Stocks can sail through a crisis-usually, Barrons March 7, 2022

2. An Emotional Market is creating Opportunities, Barrons March 14, 2022


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