While it's certainly human nature to protect what's rightfully yours and pull money out of the market during times of crisis such as these, what is the true cost of panic selling to a typical investor?

In response to the current bewildering global economic climate investors are bailing out of stocks and jumping into safer investment vehicles by the droves. $22 billion was yanked out of equity mutual funds in the 4 weeks ended 10/1/08 in stark comparison to $2 billion back in August. While an estimated $4.5 trillion still remains in equity mutual funds, the charge into bonds and cash is quite alarming.

Should You Jump Ship?

There are two schools of thought that can be applied to the decision of whether or not to weather the storm on Wall Street or jump ship temporarily. The tide unfortunately appears to be shifting towards the school favoring a bailout. However, many investment professionals are pointing to history as an indicator of what's to come and warning their clients to look before they leap out of stocks and not act purely on emotion.

I read a great article in the Money & Careers section of the Boston Globe this weekend by Ross Kerber entitled "Why it may be worth it to embrace the bear market". The piece quite eloquently discusses the potential downfalls of panic selling during the ongoing market crisis. Since it is available to boston.com subscribers (free sign-up) and Boston Globe readers only, I'll provide a brief synopsis just in case the link above doesn't work for you.

While their is no guarantee that history will repeat itself, their is a wealth of data to support the fact that investors choosing to stay in a mix of stocks and bonds for the long haul fare much better over time than those opting to switch towards a portfolio more heavily weighted in bonds and cash.

What's the Cost of Panic?

Surely, many investors, including those saving for retirement, are more concerned with not losing their hard earned greenbacks than making massive gains. However, the Globe article illuminates what T Rowe Price refers to as the "cost of panic". In a nutshell, T Rowe developed an imaginary $100K sample portfolio (60% stock/40% bonds) for a typical 55 year-old investor planning to retire in 10 years.

Their data reveals that the investor opting to maintain the portfolio during the Asian stock market crisis on '97 would have had $135,176 vs. 117,216 3 yrs later. The same investor would have ended up with $113,424 3 years after 9/11 vs. $108,933. Conversely, the portfolio would have been valued at $94,567 at the end of trading on this past Friday if left unchanged vs. $100,129.85 if migrated to bonds and cash on 9/16.

Net - Net

In my experience, irrational behavior rarely rewards itself. So, I suggest putting a great deal of time and research into your decision of how to allocate your portfolio according to what is happening today and thoroughly consulting with your financial professional of choice. Pick your battles carefully and make decisions on more of a case-by-case basis based on educated opinion rather than panic induced by troublesome macroeconomic trends.

Labels: Bear Market, Cost of Panic, Economic Trends, Panic Selling