October’s Panic Selling May Cost Investors Dearly

A few weeks ago I wrote an article titled Panic or Profit and many folks thought I was just spouting theory.  While that may be, the recent evidence of my “theory” has been proven at least half true thus far.

According to the Globe and Mail, panic sticken investors in Canada pulled a record $8.45-billion from the mutual fund market in a stampede for the exits. It was the worst month for net outflows since the Investment Funds Institute of Canada (IFIC) began collecting data in 1990, and nearly doubled the previous record posted in September, which saw net outflows of $4.5-billion.

Panic Selling

Of course many will be inclined to argue that those who pulled thier funds from the market in early October were smart and can now re-invest at lower prices.  While this is true, the figures shown are net outflows for the month – so we’re not talking about trading or churning of these funds.  This data is a decent representation of those investors who panic-sold.

Further to this point, most seasoned traders, who would be more inclined to recognize the market conditions and sell their holding to re-invest at a later date are likely not invested in mutual funds, but rather individual securities.

One such example of an individual who panic-sold is Norman Bambrick, a 72-year-old retiree in Port Perry, Ont. He bailed out of his bank fund after seeing his $200,000 investment in two accounts take a $12,000 haircut in 10 months.

“The funds didn’t work out for me and I cashed them,” Mr. Bambrick said.

“I had a feeling that they were headed for a disaster,” he said. “I had no confidence in them.”

What is even worse about this example is that the gentleman suffered just a 6% loss to his portfolio.  This is an indication that he has received some incorrect advice about his risk tolerance and the investments that he holds.

Understand Your Risk Tolerance

If Mr. Bambick could not tolerate a 6% loss to his portfolio, he should not have been invested in those vehicles.  At 72 years old, with such a low risk tolerance and relying on his portfolio for income,  Mr. Bambick should likely be invested in Guaranteed Investment Certificates (CD’s in the USA) and Fixed Income securities only. Fortunately, that is exactly what Mr. Bambick did with the proceeds from the sale of his funds.

While this example is of an investor who was not likely in the appropriate asset allocation for his situation, it is still an example of panic selling.  When we sell out of fear instead of understanding our fundamental reason for selling we often lock in losses.  And, by the time we get up enough “courage” to return to following our original investment plan (when general market sentiment turns positive), we have often missed out on the initial upside gain.

The moral of the story is this:

  • If you were lucky/smart enough to cash out before the downturn – don’t be too late to re-invest those proceeds because prices are much more attractive now.
  • If you panic-sold during the downturn get prepared and develop a plan that is comfortable for you.  Don’t miss out on potential gains when the market turns the corner.
  • If you have been holding throughout, stick with your plan because this time is not different and equities will rebound as market uncertainty eases and we return to the fundamental valuations.

I personally fall into category number three and have been buying dividend growing stocks and some index ETF’s over the past 5 weeks. 

Which category are you in?

6 comments

  1. I actually had the exact opposite action compared to the 72 year old retiree – I kept buying yesterday. I have also increased my retirement contributions since June..

    Let’s see how long this recession will be.

    Anyways, you’d think that a 72 year old would have seen other recessions and be confident that this one will be over.. I guess some people never learn..

  2. In reply to DGI:

    In all fairness to Mr. Bambick, even though he is 72 and have been through other recessions, the fact remains that he is relying on his holdings for income. I do not fully understand his circumstances, but someone who is 72 years of age may not have that time to ride out this recession. In addition, he will be constantly withdrawing the funds to meet his income requirements, thus if he continued hold his fund, he would be slowly redeeming (very likely at a greater loss) from his fund. Tyler hit the nail on the head when he wrote that Mr. Bambick (or his advisor) did not truly understand his risk tolerance and thus was not invested in something that was suitable for his circumstances.

    H

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