Fear Is Normal, but Don’t Panic

Key Takeaways

• Hope encourages resilience while fear protects us. Both emotions can lead to exaggerated perceptions, affecting investment decisions.

• Investor sentiment swings with market performance. High returns breed optimism, while low returns fuel pessimism — often unfounded.

• In volatile markets, rely on reason: Avoid panic and don’t gamble on predicting highs or lows, as no one can accurately predict them.

A TV commercial from the exuberant tech days of the late 1990s shows a young man at his office computer while a Grafware Tech stock chart shows an immense rise in its price. The man darts up the stairs with glee, hugging co-workers and toppling a tower of Styrofoam™ cups. He throws open the door of his boss’s office and announces smugly, “Mr. Dinky, I quit!”

The man then runs downstairs, only to find that Grafware Tech’s stock price has collapsed. “Oh, no!” he shouts in panic and runs back to his boss’s office. “Mr. Dinky, I’m not quitting. That was a joke, sir!”

Hope is a useful emotion, and so is fear. Hope gives us the wisdom to accept reasonable risks and the power to persist in the face of adversity. Fear guides us away from unreasonable risks and urges us to slam the brakes when the car in front of us suddenly stops. Unfortunately, hope often becomes exaggerated and turns into exuberance, while fear becomes exaggerated and turns into panic.

We cannot set emotions aside, but we can step away from our emotions and examine them with reason. This is an important lesson we learned from our parents and teach to our children.

“When angry,” my mother said, “count to 10 before you open your mouth.” Unwise words we say in the heat of anger might feel good for a moment, but words cannot be retrieved, and they can come back to bite us. The same is true for words spoken and actions taken when hope turns into exuberance and fear turns into panic. The exuberant young man in the commercial must have felt smug when he said, “I quit,” but now his days at the company are numbered.

Understanding the Impact of Fear and Hope on Investor Behavior

Fear is a negative emotion arising in response to danger, whereas hope is a positive one in anticipation of reward. However, the two are similar in that control is in the hands of others, whether other people or situations. We fear the danger of a stock market crash but can’t control the outcome, and we hope for a stock market boom but can’t control the outcome.

Exaggerated fear inclines investors to expect low returns with high risk, whereas exaggerated hope inclines them to expect high returns with low risk. A Gallup survey of investors asked: “Do you think now is a good time to invest in the financial markets?” Answers reveal that high recent returns lead investors to believe that now is a good time to invest, and low recent returns lead investors to believe that now is not a good time to invest. Evidence, however, indicates these beliefs are without foundation.

Gallup also asked investors if they believe the market is now overvalued or undervalued. Answers reveal that the months when large proportions of investors believed the stock market was overvalued were also the months when they thought now was a good time to invest in the financial markets.¹

Fear prods investors to fly to safety. The VIX Index is a risk gauge known as the fear index. It measures expectations of future risk by measuring the expected 30-day future volatility of the S&P 500^® Index. Flight-to-safety periods coincide with increases in the VIX, bearish consumer sentiment, and bond returns that exceed stock returns.²

Fear increases risk aversion even among financial professionals, whose risk aversion rises after financial busts. Financial professionals who read a story about a financial bust became more fearful than those who read a story about a financial boom, and fear led to less risky investments.³

Navigating Stock Market Volatility: Embracing Reason over Panic in Uncertain Times

Investor uncertainty amid rapidly changing news, such as shifting policy proposals around tariffs from the current U.S. administration, contributes to volatility in the stock market and evokes fear. We are right to fear stock market volatility, especially its losses. But we should not let fear turn into panic. We can’t set aside our fear of stock market volatility and losses. But we can step away from our fear and examine it with reason.

Reason in the face of stock market volatility and losses also calls for applying simple rules: Do not panic. Don’t make bets on current stock prices being too high or too low. Neither you nor I nor “experts” know when the stock market has reached its top or bottom.

Endnotes

¹Meir Statman, Finance for Normal People: How Investors and Markets Behave (Oxford: Oxford University Press, 2017), 74-76.

²Lieven Baele, Geert Bekaert, Koen Inghelbrecht, and Min Wei. “Flights to Safety.” NBER Working Paper No. w19095 (May 2013).

³Alain Cohn, Jan Engelmann, Ernst Fehr, and Michel André Maréchal. “Evidence for Countercyclical Risk Aversion: An Experiment with Financial Professionals.” American Economic Review 105, no. 2 (2015), 860-85.