By Mark Hulbert
The stock market’s recent weakness could be particularly hazardous to your wealth if you’re male, above the age of 45, married, have more dependents, or think you have excellent investment knowledge.
That’s because investors in these demographic categories are more likely to react to the market’s decline by freaking out and “panic selling.” And if you do that, odds are good that you won’t get back into equities until the stock market is much higher than where it stood when you sold—causing you to lose out to buying and holding.
In fact, according to a new study, you might never get back in. Nearly a third of investors who “panic sell” swear off equities altogether, and never re-enter the market. So they lose out on stocks’ long-term potential.
This new study would be important to review at any time, but especially now, given the stock market’s recent losses. The S&P 500 /zigman2/quotes/210599714/realtime SPX +0.16% has fallen 16% just since late March, while the Nasdaq Composite has fallen 22% /zigman2/quotes/210598365/realtime COMP +1.75% . Both declines are unusually severe for such a short period of time, causing many retirees and near-retirees to panic.
This new study appears in the Winter 2022 issue of the Journal of Financial Data Science . Entitled “ When Do Investors Freak Out? Machine Learning Predictions of Panic Selling ,” the study was conducted by a number of researchers at MIT’s Laboratory for Financial Engineering. Panic selling occurs when an investor “intentionally sells off a substantial portion of his risky assets abruptly,” and the researchers specifically define it as “a decline of 90% of a household’s equity assets over the course of one month, of which 50% or more is due to trades.”
For the study, the authors were given access to a data set consisting of more than 650,000 individual brokerage accounts between 2003 and 2015. The data set contained substantial details for many of the account owners, allowing the researchers to correlate the frequency of panic selling with various demographic variables. They found the following variables to be correlated with such frequency:
Age. People older than 45 have a “heighten tendency to make panic sales… Younger investors are less likely to make panic sales by a wide margin.”
Marital status. “Investors who are married or divorced are more likely than other groups to freak out.”
Gender. “Males are slightly more likely than females to… panic sell during periods of high financial stress.”
Number of dependents. “Investors with no dependents are least likely to panic sell.”
Self-declared investing experience . “The likelihood of panic sales and freak-outs is most pronounced when the investor has self-declared good or excellent investing experience.”
Self-declared investing knowledge . “Similar to investing experience, we find that investors who describe their investment knowledge as good or excellent panic sell or freak out in higher proportions.”
Why are these demographic characteristics correlated with an increased predisposition to panic selling? That’s difficult to answer, since correlation is not causation. The researchers don’t attempt an answer.
But no doubt many different factors interact to cause these results. If I were to speculate, I’d bet that a psychological tendency to panic plays a big role. It seems plausible that this tendency is more pronounced among investors who are older and therefore have less time before retirement for their portfolios to recover from a bear market. This tendency also could be stronger among those who have others besides themselves to support financially, explaining why marital status and number of dependents also are correlated with panic selling.
I’d also bet that overconfidence plays a role, given the poor odds that all of us face when trying to time the stock market. This would explain why self-declared investment experience and knowledge are correlated with panic selling. It would also explain the correlation with gender, as past behavioral studies have found that men are predisposed toward overconfidence.
Regardless of the causes, though, the researchers’ results are strong enough that it behooves us to pay close attention. Using artificial intelligence, the researchers construct a model to predict whether an investor will engage in panic selling, and they found that their model had an impressive success rate. This reinforces the conclusion that, if you are in one of the demographic categories associated with a higher frequency of panic selling, you need to exercise special care to ensure during bear markets to not freak out and panic sell.
Those not in one of these particular demographic categories should not become complacent, however. We all are capable of panicking, even if some of us have a greater predisposition to do so than others.
The problem is the panic, not the selling
It’s worth emphasizing that the reason not to panic sell isn’t that it’s never a good idea to sell. The problem is that we shouldn’t do so rashly, out of panic. If you’re selling according to a predetermined financial plan, good for you. Your road map undoubtedly also indicates when you should get back in, and your challenge will be not to second-guess that road map but to instead follow it.
What you want to avoid at all costs is finding yourself in the middle of a bear market—like now—without a road map. That’s because your emotions are hard to resist, and you’ll be tempted to panic and sell at all costs. Far more often than not, you’ll eventually regret the portfolio decisions you make.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org .