Risk Is Unavoidable. Panic Is Optional.

Last chapter, we discussed how and why we respond to threats: Our limbic system’s immediate surge of adrenaline urges us to take action. This has been built into us slightly cleverer primates over millions of years, an evolutionary development that has helped make our species one of the most successful on the planet.309

At least, when it comes to adaptation and survival. Our species has been much less clever in terms of allocating capital in markets than we have been in dominating the planet.

Douglas Adams’ charmingly witty absurdity The Hitchhiker’s Guide to the Galaxy begins with this reveal: Arthur Dent discovers his friend Ford Prefect is not human—he is a Betelgeusian.310 Oh, and the Earth is about to be destroyed by the Vogons, who are building a hyperspatial express route straight through our solar system.

Ford lends Arthur his copy of The Hitchhiker’s Guide to the Galaxy, which is the galaxy’s bestselling book:

It is said that despite its many glaring (and occasionally fatal) inaccuracies, the Hitchhiker’s Guide to the Galaxy itself has outsold the Encyclopedia Galactica because it is slightly cheaper, and because it has the words ‘DON’T PANIC’ in large, friendly letters on the cover.

“Don’t Panic” turns out to be excellent advice when your wetware urges you to have an immediate reaction to perceived threats (real or otherwise). Unfortunately, most of the time, this advice is useless. No one responds well to being told to “calm down!” when they are in their fight or flight mode.

To ensure you understand why “Don’t Panic” is such good advice—now, while you are sitting on the couch reading, or listening to this book in your car—let’s quantify the damage it can do.

Panic selling quantified

The easiest button to press is the one marked “Sell.” It’s a salve for your emotional distress, especially when facing volatile, disruptive stock markets. Panic selling might ease your upset stomach or help you sleep better, but it wreaks havoc on your portfolio.

The single biggest challenge of panic selling equities: How do you get back in? When? What determines your repurchase decision? What metrics do you base this Buy upon?311

My experience with panic selling was deeply influenced by the investor behavior I observed firsthand during the 2008–09 financial crisis, the 2000 dotcom implosion, and the 2020 pandemic sell-off. (Other asset managers have had similar experiences.)

It’s more than mere anecdotal—we have hard evidence to back up what makes panic selling so bad.

A very interesting study312 examined what happened when freaked-out investors panic-sold. The study was based on “the financial activity of 653,455 anonymous accounts corresponding to 298,556 households from one of the largest brokerage firms in the United States.”

An amusing finding: “Investors who are male, or above the age of 45, or married, or have more dependents, or who self-identify as having excellent investment experience or knowledge tend to freak out with greater frequency.”313

But that buries the lede. The more important issue is what those investors who panic-dumped their equity portfolios did subsequently. The most important takeaway from this research: “We find that 30.9% of the investors who panic sell never return to reinvest in risky assets.”

That is an astonishing data point: Nearly a third of investors who panic sell never buy equities again—ever! The rest of the panic-sellers repurchase equities at higher—often MUCH higher—prices than they sold for. These buys tend to be later in the recovery once the news flow improves—markets bottom when the headlines are horrific, leading to this emotional capitulation.

This is very consistent with my experience following the GFC. I cannot count how many times I was told: “I followed you out of the market in 2008, but when you flipped bullish in March 2009 I thought you were crazy.” I was getting those emails in 2010, 2011, and 2012; the big surprise was after we launched RWM in 2013, they continued, even into 2014 and, shockingly, 2015.

Panic-selling is easy, getting back in at the lows is hard, not ever getting back in is ruinous.

“Don’t Panic” is the best advice you can get when you are calm and contemplative; it is applicable in every situation you will be familiar with, whether its Vogons about to demolish your planet or the S&P futures market set to open lock limit down.

In markets, panic does not make anything better and often makes things worse—and occasionally much worse.

Coming up, we consider emotional decisions based on politics. As you might surmise, this does not mix well with investing.

  1. 309 We are in the top 10, somewhere behind fungus, bacteria, mosquitoes, crabs, and viruses.

  2. 310 From a planet in the Betelgeuse star system.

  3. 311 There is a longer conversation to be had about the tax consequences in nonqualified accounts. The simple math is that you have to overcome the big hurdle of long-term capital gains at 23.8% (20% plus 3.8% Affordable Care Act’s Net Investment Income Tax) just to break even…

  4. 312 Daniel Elkind, Kathryn Kaminski, Andrew W. Lo, Kien Wei Siah, and Chi Heem Wong, “When Do Investors Freak Out? Machine Learning Predictions of Panic Selling,” The Journal of Financial Data Science 4(1) (Winter 2022).

  5. 313 Larry Swedroe, “Men are more likely to panic than women,” The Evidence-Based Investor (March 22, 2022).