Emotional Investing
Many investors make the mistake of regularly looking at their investment accounts. In a volatile market environment, a fluctuating market value combined with drama selling media, can create a false sense of urgency to watch investments closely. If you have an overall well-balanced, diversified portfolio with the right asset allocation and a re-balancing strategy in place, there is absolutely no reason to put yourself through the agony of watching the value of your investments go up and down. Market downturns, like the one we are clearly experiencing this year, are part of the regular Expansion-Correction Dynamic of financial markets and economies around the world. An investment statement showing a lower net value than the statement before, does not mean that money was lost. It means that you are experiencing a market downturn. This misconception and misinterpretation of reality and the nature of the markets, combined with faulty advice are the main contributors to investors actually losing money.
Our human impulses can lead us to make bad decisions when it comes to money and investing - bad mistakes like selling after market downturns. Losing money feels painful. In the psychology literature, the rule of thumb is that a loss is twice as bad as an equal-sized gain. Some think that the only way to stop that painful feeling is to get out of the market. But doing that is locking in those lower values and now money is lost. Moving everything into cash would be the same. If you don't sell, you can ride that roller coaster right back up when the market recovers, which it always has eventually. Selling in the midst of a crisis, can put yourself in a position where your portfolio will never recover. So, if you're feeling really emotional about something – you are really excited or you're really afraid - that's probably not the best time to make a financial decision.
Of course it’s easier to talk about it, than to actually watch an account drop. Looking at a balance that is, let’s say $10,000 below what was put in there a year earlier, can trigger a reaction wanting to pull the brakes before it gets any worse. While these kinds of feelings are human and understandable, it has been proven repeatedly that this is one of the major hurdles to reach performance goals.
What about additional investing? Should you keep putting money into an investment account, given where the markets are? The answer is yes, you want to keep investing. In times like that, you're able to take advantage of the lower-cost value stocks in the market. Unfortunately, emotions will trick us here as well. While many feel encouraged to invest more money after a positive year in the market, many feel discouraged to throw more money at something that has just ‘lost’ in value. It should be the other way around. We're all going to go for a good sale at the grocery store, in the mall or our favorite clothing store. Why not for investments? Think about it that way.
Having said all that, it is not quite as simple and the same for everyone. There are more components to successful investing than just keeping your emotions in check. Your age, long term goals, income expectations, tax circumstances, risk aversity and most importantly your time horizon for taking income must be considered when designing and maintaining your overall portfolio. It is also important to have the right investments. There are companies that take longer to recover or may not recover at all after a downturn and need to be eliminated from your portfolios. All that is part of having a well balanced diversified and actively maintained portfolio and will be especially important in 2023 with a possible recession and very selective market.
