How Loss Aversion Hurts Investors and How Advisors Can Help

In May, the S&P 500 brushed bear territory before recovering to end the month down 14% from its January 2022 highs (see Figure 1).1 Advisors fielded calls from panicked clients desperate to sell as pundits offered a grim market outlook against the backdrop of rising interest rates, spiking inflation, ongoing supply chain disruptions, and war in Ukraine.

Investors Push Markets Toward Bear Territory

The May crash was neither as deep nor as quick as the March 2020 dip that followed the emergence of the COVID-19 pandemic—and preceded a long market rally that lifted the S&P 500 to record highs (see Figure 2).2

Nevertheless, as inflation hits multi-decade highs and markets for everything from cars to crude oil to baby formula face record stress, investors are fearful that this year’s downturn will be enduring, brutal, and relentless. Eager to stop the bleeding in their portfolios, investors are rotating out of stocks and taking up defensive positions in cash, bonds, and other assets.

As more and more investors sell, the market falls further and further in what is—to experienced traders—a familiar cycle. Fear breeds fear and falling markets drive further falls, a downward spiral that can play out over many weeks or months.

Yet, as frightened investors seek to stem their losses by issuing urgent sell orders, the astute advisor should be asking: Is this behavior wise?

1 S&P Global. S&P 500 Data. June 6, 2022.

2 Financial Times. U.S. Stocks Fall on Fears of Slowing Growth. May 24, 2022.

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