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AAII InvestoGraphic

The Cost of Panicking

Getting out of the market due to fear over falling prices has a lasting, negative impact on your wealth.

by AAII Staff | March 2018

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The return gap, also referred to as the behavior gap, is the underperformance investors incur through their own actions. By getting in and out of the market rather than sticking with a well-thought-out allocation strategy, investors cost themselves wealth.

Both charts assume an investor invested $100,000 at the start of 2000. The investor’s target allocation was 100% to the Vanguard 500 Index fund (VFINX), which tracks the S&P 500 index. The panic scenarios assume this investor switched to all bonds via the Vanguard Total Bond Market Index fund (VBMFX) for 12 months after the S&P 500 fell by more than 20% during a calendar year. After being out of stocks for a year, the investor is assumed to have gone back to the 100% equity allocation.

This first chart shows what would have happened to the portfolio’s value had the investor either stayed fully invested or panicked at the end of 2002 and the end of 2008.


What You Do After You Invest Matters More Than When You Invest
What You Do After You Invest Matters More Than When You Invest

 

This second chart shows the ending portfolio values for a $100,000 investment made in the Vanguard 500 Index Fund at the start of 2000. Four scenarios are used: stay fully invested, panic only at the end of 2002, panic only at the end of 2008 and panic at the end of both 2002 and 2008. All three panic scenarios assume the investor went back to using a 100% allocation to stocks 12 months after panicking.


$100,000 Invested From 2000 Through 2017
$100,000 Invested From 2000 Through 2017


Discussion

Dave Gilmer from WA posted over 8 years ago:

Besides staying in your investments, what matters more is making them early and often. I can only look on in envy at a friend who started investing in the Vanguard index fund VFINX back in 1976 and has stayed with it all these years!


Neil Micke from WI posted over 8 years ago:

The assumption is always made that the investor will bail at the lowest point and return after the market has a big resurgence. The 2000 bust occurred while we were stilling working and earning. However the 2008 bubble occurred while retired. Prior to 2008, we had projected a comfortable retirement. All we needed was 2% above inflation for comfortable retirement and a modest estate at the end of it. After the bust, staying fully invested, caused a significant belt tightening with not estate and serious thoughts of going back to work at minimum wage. We are now back to the modest estate after 9 years.


William Baker from NM posted over 8 years ago:

As usual the buy and hold fatalists cherry pick their data to bash market timer opportunists. Market timers don't wait until Dec. 31 to bail out of a losing situation. Nor do they wait 12 months to re-enter. How about testing some rational market-timing strategy, like selling one day after a drawdown of 20% and re-entering at the end of the next positive quarter? I don't know the results, and I'll admit you could get whipsawed to death with this approach. But if you backtest a period that includes two crashes, any system that limits drawdowns will start with a huge advantage over buy and hold.


Charles Rotblut from IL posted over 8 years ago:

William, If anything, I'm being too conservative with my calculations of how much people lose when panicking. The data on mutual fund flows and investor returns on mutual funds both show investors pull out during bear markets and wait too long to get back in. -Charles


James Heal from CA posted over 8 years ago:

William, Not sure how you are allocated but having a diversified income plan for Retirement means less market risk worry. Consider an approach where protected income (SS,Pensions, Personal Pensions/fixed-COLA annuities) cover most of your non-negotiable monthly expenses and the 4.5% rule for your invested, i.e. still at risk, assets-used for discretionary spending. -Jim


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