How to Avoid Making Emotional Investments
Let’s face it: investing can get emotional. Especially when the market is falling, it’s easy to get scared and sell. But when fear drives you out of the market, fear will usually keep you out during much of the recovery that inevitably follows. Here are some ways to keep your emotions from getting the best of you, and a couple of ways they actually can be beneficial.
How to Avoid Getting Emotional About Your Investments
It’s impossible to set your emotions aside all the time. But, especially if you are a beginner in investing, there are some steps you can take to minimize their negative influence.
Put your investment plan in writing. Committing your plan to paper, especially when the markets are calm, and then re-reading your plan when the markets aren't so calm, can help guide you through market storms. Importantly, such a plan should include what you will do (and not do) when the markets get rough.
Ideally, you won’t make any changes. That’s a clear sign you’ve carefully chosen one of the best investment strategies because you can live with it in good times and bad.
Know some market history. Despite appearances over the past nine years, the market doesn't always move up. Even in high-return years, the path is usually marked by many ups and downs. Take 2013 as an example. While the S&P 500 ended up more than 30 percent that year, there were six notable downturns along the way. Each time the market slipped, you can be sure some investors wondered whether it would continue to fall, and if so, how far.
Understanding something about market history can go a long way toward managing your expectations, and that can help keep you from overreacting to a downturn. Generally, it’s helpful to know that the market cycles between bull markets and the difference between a bull market and bear markets. The fact that the market’s long-term trajectory has been upward meaning bull markets usually have lasted longer than bear markets and they’ve added more value than bear markets have taken away.
That may not make a sharp downturn easy to take, but it should make it easier. To be successful with investing, you should expect some bad days, months, and even years, and not let them cause you to abandon your plan.
Don't check your portfolio so often. Research has shown that the more frequently people check their portfolio, the more they tend to trade. Here’s why. Looking back on all of the individual days the stock market has been open, just a little more than half of those days have seen a positive return. So, if you check your portfolio every day, the odds are roughly 50-50 that the market will be down.
That’s a lot of potential pain to put yourself through. Since behavioral economists have found that people tend to feel the pain of loss more acutely than the pleasure of gain, checking your portfolio every day leaves you vulnerable to many emotional overreactions.
The solution? Commit to checking your portfolio less often. Historically, the longer the holding period, the better the odds that the market will be up. So, the longer you go between portfolio check-ins, the better.
Outsource your portfolio management. If you find that you just can’t handle the market’s fluctuations, consider having your portfolio managed by a financial advisor. Sure, you’ll pay a fee for this assistance, but it may be well worth it if it helps you keep a steadier hand on the wheel. Of course, make sure you’re in on and agree with the plan developed on your behalf. Then ask your advisor for portfolio updates no more frequently than once a quarter.
Why Getting Emotional About Your Investments Can Sometimes Be Useful
While your emotions can lead you astray, there are times when they can be helpful.
You assess your risk tolerance. Your comfort level with risk is one of two key factors that determine your optimal asset allocation (the other is your investment time frame). It’s usually determined by answering questions such as, “Try to imagine that a stock you held lost 30% in three months. Would you sell your remaining holdings, sell some of them, do nothing, or buy more?”
While your risk tolerance is the most subjective factor in your investment plan, it’s important to honestly consider how much financial pain you can handle and build your portfolio accordingly.
Your risk tolerance gets tested. The other time when emotion can be helpful is during a market downturn. You see, typically, your risk tolerance is first determined at a time of relative market calm. But there’s nothing like a sharp downturn to find out just how accurate that initial assessment was. Even though a portfolio designed with your risk tolerance in mind should enable you to handle downturns, you never really know until a sharp downturn hits.
If you find it too painful, perhaps your risk tolerance isn’t as high as you thought. Still, it’s best not to sell during a downturn. Wait until the dust settles and then consider whether to make any adjustments to your portfolio.