Investor sentiment has rapidly declined over recent months. Risks to the economy and stock market’s prospects, such as geopolitical challenges in Europe and an increasingly tight monetary policy in the U.S., have caused the Volatility Index (VIX) to rise by around 95% year-to-date, with a higher reading suggesting greater fear among investors.
However, it is important for individual investors to avoid acting irrationally due to the fears of others. Just because other investors are nervous about the future prospects for their portfolios does not mean you should immediately sell all your stocks.
Fearful investors do not usually make optimal decisions on how to manage their portfolio. For example, they may currently be looking to sell stocks and avoid new purchases because they are worried about the near-term prospects of the economy. This may mean they miss out on today’s low prices that could prove to provide sound long-term investment opportunities.
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously highlighted the potential for fear to become endemic across the investment community. As he once stated, “Fear is the most contagious disease you can imagine. It makes the virus look like a piker.”
Avoiding the ‘disease’ of fear
In my opinion, a simple way for investors to avoid becoming fearful is to conduct themselves in a businesslike manner. This means that they seek to put emotions to one side and make rational decisions using facts and figures.
For example, other investors may be concerned about the potential impact of rising interest rates on corporate profitability. However, an investor who knows that their holdings have modest debt and high interest coverage ratios (the number of times debt interest payments are covered by operating profit) is unlikely to be worried.
Similarly, an investor who knows that a specific company has a large competitive advantage over peers, as highlighted by its consistently high return on equity figure, is far more likely to take advantage of value opportunities rather than sell in a panic. They are unlikely to worry about its near-term prospects, since they understand that its long-term outlook could in fact be improved by a short-term economic slowdown that cause irreparable damage to weaker peers.
A patient outlook
Of course, it is difficult to completely put emotions to one side when managing a portfolio. In my opinion, it does become easier after experiencing several bear markets. Investors who have seen the stock market crash and recover several times are likely to be less fearful about the recent decline and more confident that it will ultimately bounce back.
Investors who have not experienced numerous bear markets and subsequent bull runs may wish to consult the past performance of the stock market. The S&P 500 has recovered from 26 of its 27 bear markets since the Wall Street Crash in 1929. Although a recovery from its current bear market is not guaranteed, it seems incredibly likely to take place.
Focusing on business fundamentals and the long-term stock market history can act as a reminder that fear is likely to be misplaced when it comes to the long-term. Rather, the uncertain outlook presents buying opportunities for long-term value investors.
