The Psychology of Investing in the Wake of Historic Market Crashes

Glad to have you back inside Mr. Stillman's Opus. I'm Ben George, along with John Stillman at Rosewood Wealth Management. You also might have read his book, The Financial Buffet, or even read the blog, The Financial Beat.

John does a little bit of everything. And John, today we're talking about market crashes. Are you an expert in this area too?

An expert? Well, I'm not convinced anybody's an expert on it, but I guess I probably know more about market crashes than the average person walking around, hopefully. Well, we've been through a few of them in recent years. Today, I want to dive into it a little bit more and really kind of talk about the psychology of investing in the wake of a market crash. And not just any market crash, because, you know, I don't know how you would actually define a market crash. Is there an actual technical definition of that? Because it feels like the market crashes pretty frequently, but not like what we're talking about today where we're talking about some of the bigger ones over time.

Yeah. So a term like market crash doesn't necessarily have a specific definition. Now, something like a bear market does technically have a definition. Technically, a recession has a definition.

But market crash is kind of a relative term, I guess. Okay. It means different things to different people.

Okay. Well, the psychology of this, the kind of what we discussed today is just kind of talking about, you know, how behaviors change in the wake of these things happening. Because, I mean, I think you experience it with people all the time, especially in recent years. I mean, we're dealing in the hills, I don't even know if we're out of the latest market crash, technically or not, without having a definition. Maybe it's harder to define. But I guess you're seeing this kind of constantly now, right?

Just dealing with these different behaviors and probably conversations change with people based on how they're feeling about the market. Well, so I think the point is that market crashes always leave a scar of some sort. And it could be that, you know, maybe it doesn't really affect your behavior that much.

Or it could be that even if you don't realize it, subconsciously, it kind of imprints something on your brain that you remember for the rest of your life. So actually, if you'll let me wander down a rabbit trail here, I'll give you a biblical example of this idea. So Second Samuel, David has become king. So Saul was king of Israel before David. And when David takes the throne, normally what a king would do would be to go kill anybody in the family of the previous king, so that nobody else can possibly have a claim on the throne. Well, David doesn't do that. David says, is there anybody left in Saul's family that I can show kindness to? And so they say, yeah, well, he has this grandson, Mephibosheth, who is crippled. So David brings Mephibosheth in. He says, hey, I'm going to give you your grandfather's estate. You know, you keep that property. You can dine at my table. He's very kind to poor, crippled Mephibosheth, grandson of King Saul.

All right. So that, you know, if you've spent a lot of time in the Old Testament, you probably know that story about David and Mephibosheth. Fast forward, though, I don't know, maybe 20 years, several chapters later in Second Samuel, David has been king for a while. Now David's son Absalom has grown up and is fomenting a rebellion against David. Absalom is trying to take the throne from his dad. And so they go out, they have a battle. They're fighting against Absalom's men. And so Mephibosheth tells his servant, basically, hey, you know, go out with David and fight on my behalf.

Obviously, you know, I'm crippled. I can't go do it myself, but you go fight for me. Send David my best. So this guy, Ziba, goes out. He meets up with David on the battlefield and David says, hey man, good to see you. He's like, yeah, you know, Mephibosheth wouldn't come. Mephibosheth is on Absalom's side, but I came to fight with you. And so David's, of course, furious, right? Because he told Mephibosheth years ago that I'm going to give you everything that was your grandfather's. So now David's mad after the kindness he's shown to this guy that Mephibosheth would turn and take the side of Absalom. And so, by the way, Ben, I promise there's a point to this story.

Okay. So David's mad and he tells Ziba, he says, well, look, that stuff that I gave to Mephibosheth years ago, it's now yours. You get everything that belonged to Saul.

You get the whole estate, the property, everything. And so they get back to Jerusalem, you know, David's men win the battle. David comes back to Jerusalem to take his throne back.

And there's Mephibosheth. And he says, oh, David, I'm so happy you won. I'm so pleased that you keep your throne. Sorry that I couldn't fight, obviously. And David's mad at him. He's like, why would you act like you're happy to see me?

I know that you're with Absalom. You didn't even come fight. And Mephibosheth is just like, dude, look, I can't walk.

How am I going to go fight in a battle? And then it kind of occurs to David, oh, yeah, Ziba lied to me about that. So he says, well, I'll tell you what, Mephibosheth, you get half of Saul's stuff and Ziba gets the other half. And that's the end of the story. And you say, what?

Like, that's not gratifying. Why does Ziba get half of the stuff after he just lied about the whole thing? Of course, Mephibosheth was loyal the whole time.

Why would he not get to keep the whole property? And there's never an explanation of this in the Bible. But back in the Jewish oral tradition, the explanation is once somebody tells you something and you believe it, even later, when you're confronted with the facts, you can't ever quite stop believing it.

So basically, once you've accepted something as truth, it becomes imprinted on your brain in such a way that you can't completely just dismiss it down the road. It's always going to kind of be there. And that's sort of what we have with different market crashes. If at some point in your formative investing years, something became imprinted on your brain in terms of how the market works, no matter what happens down the road, even if it's subconscious and you don't necessarily recognize it, that voice is still there in your head.

I like it. That's a great actually great story to tie into this, for sure. So let's examine then specifically some of these big events and the lasting impact and maybe the fallout psychologically for investors on the back end of these things. Now I'm going to go back to some, Jon, that you weren't around for, that you weren't planning for, and you weren't helping people with over at Rosewood Wealth Management. Let's start with the Great Depression.

This is the one, the mother of all market crashes, I guess. This is the one we still point back to. And I'm sure there are still plenty of people that you work with and talk to that through their family and their upbringing are still impacted by this. So not only was I not around for the Great Depression, but most people that we're working with as clients were not around for the Great Depression.

That generation obviously is going away pretty quickly. But, you know, earlier on in my career, I certainly did have people who had lived through the Depression that were old enough to remember it. I mean, we have a lot of clients that were born during the Depression, but they don't remember enough about it that it's really formative memories for them. I mean, our oldest clients now are in their mid 80s. So, you know, they were born in the 30s.

Let's say we've got a few that were born probably in 37, 38, back in that era. But, you know, that was kind of toward the end of the Depression. So it's not like they remember it. But 10 years ago, we did have clients who remembered it well. And all those lessons learned, like when you're a kid and you know how scarce money is and how hard it is to get food, that kind of stuff sticks with you for the rest of your life. And, you know, a lot of those people sort of had hoarding mentalities. A lot of people never really got comfortable with spending money because back in the back of their mind, they're thinking, well, it could all go away tomorrow because of those formative memories. Now, let's go back even further for people who maybe were in their 20s or 30s when the Depression happened.

You and I don't know any of those folks, Ben, because they died out many years ago. But for those people who actually had money invested in the market in the late 20s and early 30s, and they saw the market lose 90% of its value in the course of just a few years, they're never going to fully trust the market again. And yeah, they might have invested in the market later on in the 40s, 50s, 60s, but they could never fully trust it because of what they experienced early on.

Well, right behind that was the wars, right? World War II, especially the market following the war, post-war, boomed. And it's kind of a different angle on this because while the Depression obviously made people much tighter with their money and made them worry much, much more about the markets and the trusting the system, I guess, the opposite could be said about people investing following the war because they got used to some pretty nice returns year after year.

Yeah, so this is basically the opposite of what we were just talking about with the Depression folks. People who started their investing career early on in the post-war era. So this could be people that were born during the Depression and maybe they were just coming of age, just starting to invest in this great boom in the market. If that's one of your formative investment memories, then the market was growing 15, 16% per year on average for more than a decade.

I mean, that is absurd sort of returns. And if you saw that early on, then you're going to always think for the rest of your life, the market is the absolute best place for every penny of my money because you end up trusting it too much, just like the people who lost all that money in the Depression in their formative investing years. If your formative years as an investor are in a boom, you're going to end up trusting the market too much.

Yeah, that would be a nice spot to be in early, but definitely could hurt you down the road. Behind that in the 70s, late 70s, early 80s, and I guess you could even lump today into this category, soaring interest rates. If your first exposure, John, ended up being the interest rates they had in the 70s and 80s, you might look at today and well, maybe not today exactly, but the last few years, last decade in a totally different light. Well, this is very much something that we see with our clients because they were conditioned in the 70s and 80s that, hey, the bank is a great place for lots of money. And especially if they happen to have some formative memories about the market that were negative, the problem is exacerbated by the fact that they have feelings about the bank that are positive. So even though we've had this long period with low interest rates where they're getting absolutely nothing on CDs or savings accounts or anything like that, even with this long period, their formative memories tell them, well, the bank is the best place for my money. I get interest on money at the bank. So whatever I'm enduring right now where I'm not getting any interest, that's just an aberration.

That's not reality. It's all going to eventually get back to where it was and the bank will be the best place for my money. And so again, just like people who formed their memories in the boom years of the market, well, if you formed your memories about the banking system during the booming years of the interest rates, you're going to trust the bank too much, just like these other people trust the market too much. And so you just have to at some point say, all right, well, interest rates haven't been like the ones that I remember from 40 years ago. It hasn't been like that in 20 years. So at what point do I just accept, okay, we're living in a different world now. But again, once it's imprinted in your brain that this is truth, it's hard to change that story.

Right. We're talking about market crashes, major financial events that change your perspective on investing and how you approach money. Let's go fast forward a little bit to more recent times and let's start to 2008. Obviously, this is one of the great recession that we all still think back. And I think you can correct me if I'm wrong, John, we're 15 years beyond when this first started, but I think still people are still thinking about that. And any time that like the banks have issues or the real estate market picks up a lot of steam, there's always this, hey, is this 08 all over again?

Yeah. Well, so this is actually kind of my formative years in the market, right? So I finished college in 2006. And so this 2008, 2009 downturn was basically right when I was at the age where I was starting to put money into the market, which I think I understood enough at the time to realize that, you know what, this is actually good for me.

I'm buying stuff on sale because the market's down. I think I intuitively understood how that works. Even though I wasn't in the financial industry yet, I think I just had an intuitive understanding of how that worked.

A lot of people don't have that intuitive understanding. And so they may have seen, let's say you started investing in 2005 and you actually built up a little bit of money, you know, 20,000, $30,000 over those few years. And then you saw it get cut in half in 2008. Well, if you're 25 years old and you see your retirement money get cut in half, that's going to form an impression on you. It's going to imprint something in your brain. And yes, you're going to have, like you just said, Ben, every time you start seeing things that maybe on some small level remind you of 2008, the tapes are going to start playing and you're going to say, huh, is this 2008 all over again? You're right. That's exactly how it is for a lot of people, especially folks that are currently in their forties and fifties, because that was in a lot of cases, the biggest investment loss they'd seen.

Well, it definitely was the biggest they'd seen. In a lot of cases, it was the first big loss they'd seen because maybe they were a little too young to have really experienced the dot com crash with any significant dollars. But 2008, for a lot of people, a lot of our current pre-retirees, they remember that one because that was the first time they had enough money to really notice when they took a hit like that. Yeah, this I'm in the same boat as you in terms of this being my formative years, too. I also wonder sometimes if if maybe it has a different impact on us, like we saw the bounce back, right?

Sure. It took a few years and we didn't have as much money in there. So when you're when your account drops from 50 percent from three thousand fifteen hundred has a different feel to it. But then you see the reverse side of that when everything picks back up and suddenly your accounts shooting up. Do you think even it can be a detriment to us where when 2020 rolls around, we can jump into here that we think, oh, well, we'll definitely come out of this.

I'm just going to keep pumping money in the market because I'm getting everything at discount. Do you think it does in some way harm our approach because of what we saw in 08 in the following years, following decade? Well, it very well could. That's an answer we may not have until we have the benefit of retrospect. So let's revisit this question in about 20 years when we're both 60. But yeah, I mean, it could very possibly affect us in ways that we don't even realize.

You mentioned 2020. Yeah, that one's interesting because I think that has different effects on different people. For some people, it's just another example of, well, I can't trust the market. Look how much it lost so quickly. I mean, we did lose 30 percent in a month. It was an insane 30 days from mid February to mid March of 2020 was one of the worst 30 day stretches of my life.

But by July, we were right back to where we'd been in February and then we grew from there. So some people look at the 30 day stretch and say, oh, I can't trust the market. A lot of people look at March through July and say, well, it always comes back, so I'm never going to worry about a downturn. So different people can walk away with different lessons from some of these things. And the point of good financial planning, good investing is you need to understand what your own biases are. What are the voices in your head that might be subconscious? You don't even know that the tapes are playing in your head, but they are. Let's start to recognize how you interact with money based on those tapes that are playing in your head. And let's make sure that you're not letting those tapes get in the way of you making the best decisions that you can make.

That's a great point. Well, if you want to follow up, sit down with John and start kind of working through your plan, making sure you're addressing maybe some of these behaviors within your investments. You can always get in touch with John. Eight hundred five four five two nine nine one again. Eight hundred five four five twenty nine ninety one. Collar text.

Rosewood Wealth Management. And I get these things worked out. Well, we'll see what happens over the next couple of decades, John. But I know it will be there will be another market crash at some point that will shape our our kids generation as well.

It's just inevitable, right? I'm sure there will be. And we'll see if anybody tunes into the next episode after I spent an hour and 17 minutes talking about David and Mephibosheth. We'll see. Very good. Thank you, John, for your time and thank you for listening to Mr. Stillman's Opus. We'll talk to you again soon. Carolina Wealth Stores doing business as Rosewood Wealth Management is a registered investment adviser in the state of North Carolina. The material presented is intended to be general information and should not be construed by any consumer as the rendering of personalized investment advice.