Between tech stocks and tariff news, it’s been a tough couple of weeks for investors. Just this week, stocks traded lower on news of a possible trade war with China before rallying later in the day. Last week, the New York Times reported that Facebook lost a mind-boggling $100 billion in market capitalization since Feb. 2, and that investor concerns about the Cambridge Analytica scandal had spread to other popular stocks – in particular, the so-called FAANG stocks, which include Facebook, Apple, Amazon, Netflix and Google, as well as the social media network Twitter. While experts generally believe we’re still in a bull market, some are raising concerns about slowed growth, as trade protectionism, data scandals and belt-tightening by the Fed heighten the risk of volatility.
When the Heart Says “Buy”
When market uncertainty strikes, many investors make decisions with their hearts instead of their heads. Naturally, emotions run high when the market is lurching up and down. Making decisions and acting when you are fearful, anxious, or panicking could harm your portfolio in a way that may be unrecoverable. But making decisions and acting when you are confident in the market, or excited about the growth of your portfolio, may also have negative effects and unintended consequences.
Are you an emotional investor? View the signs in our infographic.
While no formal definition of an emotional investor exists, plenty of indicators can help you tell whether your investing decisions are more emotion-driven than they should be. For example, if you find yourself selling your holdings when you have small declines in value, that could mean you are an emotional investor. Another indication could be that you feel fear or anxiety when learning news about the stock market.
Perhaps the biggest downside to emotional investing is lower returns. That’s because many emotional investors act at precisely the wrong times. They sell their stocks when they are fearful, which is also usually when valuations are low. Then later, they notice the hype around market trends and buy back in to the market when valuations are high. This is the exact opposite of the “buy low and sell high” strategy that has fueled the markets since Day One.
The most recent DALBAR study of investors found that investor behavior results in about a three-to-four percent underperformance per year. It’s a huge penalty to pay for acting on emotion, and one that may impede some investors from reaching their goals.
The good news is that you can overcome emotional investing with the right strategies. Here are four steps you can take to help keep your cool during volatile markets:
- Have a plan. Creating a personal investment policy will help to give you direction. When you start with your goals first, you will be able to make decisions that support those goals. You will have a policy to refer to in times of nervousness or anxiety, and your policy should help you stay on track, always working towards the goal. When drafting a policy, be sure to to include your asset allocation, your criteria for rebalancing, and your monitoring procedures. If you can commit to these items and get them down on paper, you will be much less likely to deviate from your plan and make an emotional decision.
- Stay invested. Keeping a long-term view of investing is critical to your success. Markets decline – we know they will! What we don’t know is when they will decline, but generally, when markets decline, they eventually rise again. Being in the market when this growth happens is crucial for your portfolio. Because we don’t know when the decline and growth will happen, the only way to capitalize on the growth is to stay invested even when the market declines.
- Diversification works in tandem with staying invested. Not all asset classes perform the same way at the same time. Diversifying gets you invested in many asset classes so they work together and smooth out the ups and downs of your portfolio. Some may go up; some may go down; but over the long term, your portfolio has a chance to experience overall growth. Staying invested and diversifying are the main components of Modern Portfolio Theory, an academic approach to investing that gives guidance and helps to avoid investing on emotion.
- Use a professional adviser. Emotions can be powerful motivators to take actions. You may have a plan and understand the importance of staying invested and diversified, but you can still make mistakes. An independent, fiduciary adviser can be the voice of reason that keeps you from acting against your own best interests when you’re tempted to do something rash.
At AMDG Financial, we’ve seen what happens when the heart rules the head. That’s why we follow a defined process with our clients to help them realize their goals. Our holistic approach not only considers investments, but also how they integrate with an individual’s tax and financial strategies. If you’re concerned about how volatility in the market could affect your portfolio, please contact us to learn how we can help. It would be our pleasure to serve you!