By |Published On: October 12th, 2014|Categories: Behavioral Finance|

Stock markets have been sucking wind recently.

S&P

sp

R2K

r2k
When I listen to the nightly news or indulge in 30 seconds of CNBC during the day, it seems as though the world is coming apart at the seams.

Perhaps a correction is on the horizon, and with a long enough horizon there is a 100% probability the market will blow up (e.g., the sun becomes a Red Giant and the Earth is liquidated).

But when consuming information we must always worry about availability bias, which causes our minds to overweight the probability of events that trigger primal instincts such as fear and greed.

Some headlines:

But just how big a deal is a 5% loss in the stock market?

The table below highlights the top 40 worst drawdowns from 1927 to 2013–all of them are worse than 5%.

We include the S&P 500 total return index (Large cap) and the Equal-weight CRSP total return index (small-cap).

One thing is clear:

INVESTING IN THE STOCK MARKET IS INCREDIBLY RISKY

Rank Date Start Date End SP500 EW_CRSP
1 8/30/1929 5/31/1932 -84.59% -85.86%
2 2/27/1937 3/31/1938 -51.27% -61.18%
3 10/31/2007 2/28/2009 -50.21% -55.19%
4 8/31/2000 9/30/2002 -44.41% -23.78%
5 12/31/1972 9/30/1974 -42.73% -49.86%
6 8/31/1932 2/28/1933 -30.38% -38.68%
7 9/30/1939 4/30/1942 -29.81% -21.00%
8 8/31/1987 11/30/1987 -29.58% -32.02%
9 11/30/1968 6/30/1970 -29.23% -48.32%
10 12/31/1961 6/30/1962 -22.33% -23.03%
11 5/31/1946 11/30/1946 -22.17% -28.13%
12 1/31/1934 3/30/1935 -21.89% -23.08%
13 8/31/1933 10/31/1933 -19.76% -24.17%
14 12/31/1938 4/29/1939 -17.01% -20.28%
15 11/30/1980 7/31/1982 -16.53% -12.82%
16 4/30/2011 9/30/2011 -16.26% -22.15%
17 1/31/1966 9/30/1966 -15.79% -15.70%
18 6/30/1998 8/31/1998 -15.18% -23.70%
19 7/31/1957 12/31/1957 -15.13% -18.37%
20 5/31/1990 10/31/1990 -14.82% -24.33%
21 12/31/1976 2/28/1978 -14.46% 25.53%
22 4/30/2010 6/30/2010 -12.93% -13.54%
23 7/31/1956 2/28/1957 -9.90% -3.90%
24 2/29/1980 3/31/1980 -9.75% -16.50%
25 8/31/1978 10/31/1978 -9.43% -17.22%
26 12/31/1952 8/31/1953 -9.01% -5.88%
27 6/30/1943 11/30/1943 -8.81% -11.80%
28 12/31/1959 4/30/1960 -8.42% -7.38%
29 8/31/1986 9/30/1986 -8.32% -5.91%
30 4/30/1971 10/31/1971 -7.87% -13.65%
31 3/31/1936 4/30/1936 -7.78% -12.30%
32 11/30/1983 5/31/1984 -7.21% -12.44%
33 1/31/1994 3/31/1994 -6.95% -5.55%
34 12/31/1989 1/31/1990 -6.77% -4.64%
35 12/31/1967 2/29/1968 -6.77% -3.36%
36 3/31/2012 5/31/2012 -6.60% -7.69%
37 9/30/1979 10/31/1979 -6.56% -9.79%
38 1/31/1946 2/28/1946 -6.54% -6.69%
39 6/30/1999 9/30/1999 -6.22% -3.75%
40 3/31/1956 5/31/1956 -5.90% -3.63%


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Knowledge is power and knowing the facts regarding the risks associated with stock market investing can help you put the current market movements in context. Does losing 5%+ stink? Of course.

But is the movement worthy of stirring behavioral emotions (e.g. fear or greed) that will almost certainly cause you to make a bad decision? Not even close!

  • Stay calm.
  • Stick to your program.
  • Never associate more activity with increased value.
  • Focus on evidence, not on stories.
  • Avoid television, which is systematically designed to trigger emotions that cause you to “react.”
  • Avoid advisors who recommend off-the-cuff “tactical changes.” These tactical changes justify an overpriced existence, but rarely equate to systematic value-add.
  • Avoid the stock market if you cannot take risk!

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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