Here’s the Risky Move Many Investors Made Due to Fear of a Recession

"Recession" is a scary word in the world of finance, and a powerful one. The threat of a recession alone is apparently enough to push some investors to fiddle with their investment portfolio.

A recent report from investment research company Morningstar details how investors reacted to last year's recession doomsaying. About half of investors polled prepared for a recession they believed was coming by taking investment-related action, like buying or selling stocks.

The report highlights a move you should avoid when making important financial decisions: Reacting out of fear of what could happen in the short term.

"Although the best advice for many investors tends to be to stay the course and wait out the storm, behavioral biases can make it difficult to do this," authors of the report wrote.

Avoiding rash investing decisions

The survey of roughly 1,000 pre-retiree U.S. investors in December 2022 showed that 68% of respondents saw a recession on the horizon, and 48% were worried about how this potential recession would impact their financial situations.

With recession fears riding high for many investors, about half of respondents took some kind of investment-related action, like buying or selling stocks or making changes to their financial plans. While 19% bought stocks as a result of recession fears, 13% sold them and 22% updated their financial plans.

Nearly 4 in 10 took what Morningstar calls "imprudent actions." What makes an action imprudent, according to Morningstar, is the timing. Cashing out stocks at a time when many experts are saying to keep holding is one such example. It's not that the action itself is an irrational one (there are plenty of circumstances where it's reasonable to cash out your stocks), but rather that the action is timed poorly.

Investors who made these "imprudent" decisions tended to be those most worried about a recession. While it may be tempting to get ahead of an economic downturn by making changes to your portfolio, it's usually better to stick to your long-term strategy and carefully consider any changes.

"People do not always make the best decisions when they are scared, and a knee-jerk reaction, like trying to time the market during volatility, can be costly to investors in the long run," the authors of the Morningstar report wrote.

After all, a recession is looking less likely than it was back in December 2022, meaning that those who messed with their investments based on fear may have done so unnecessarily.

The bottom line

Ultimately, the report demonstrates common investor behavior: the temptation to shuffle around investments when you're scared.

Investors carried what was, at the time, a reasonable amount of fear of a coming recession. And to be clear, it's not always bad to make changes to your portfolio, especially if you see legitimate evidence of trouble on the horizon that may mean your portfolio will stray from being aligned with your goals, time horizon and risk tolerance.

However, making rash decisions can cost you. Investors who are quick to make changes to their portfolios face the risk of missing out on the market's best days. JP Morgan's 2023 retirement report, for example, shows that investors who missed just 10 of the S&P 500's best days between 2003 and 2022 saw less than half of the returns compared to investors who kept their money in the market.

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