A new study by renowned Yale economist Robert Shiller shows that investors consistently overestimate the likelihood of a big stock market crash in the next six months. Investors put the odds of a crash at about one-in-five. In reality the odds have been around one-in-seventy, according to Empirical Research Partners.
The study asked the following question over 26 years: “What do you think is the probability of a catastrophic stock market crash in the U.S., like that of October 28, 1929 or October 19 1987, in the next six months, including the case that a crash occurred in other countries and spreads to the U.S.?”
Interestingly, the results (adjacent) are similar for both institutional investors (who invest on behalf of big entities like pension plans and insurance companies) and high net worth individuals.
A helpful distinction can be made between a market crisis and a catastrophe. Periodic crises – e.g. geopolitical tensions, natural disasters, recessions, etc. – are a normal part of investing. A diversified portfolio is designed to see you through such periods. Catastrophic stock market declines like those cited above are historically rare. While a crash can never be ruled out, we find that investors who live in fear of a crash often make poor decisions, including sitting on the sidelines while markets move higher.
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