Emotions can run high when it comes to investing, especially during periods of stock market volatility.
Let’s say you wake up on Monday morning and check your portfolio. It’s up 7%, which is great! Humming a little tune, you log out of your account and go about your day.
Two days later, you check it again. This time, it has dropped 11%. Oh dear. But you remind yourself that this is often the way of volatile markets. Unsettled, you log out and try to find something else to occupy your mind.
On Friday, you timidly log back into your account hoping to see lots of green but fearing red. You immediately regret it because now your portfolio is down 15%. For the rest of the day, your thoughts return to your rapidly dwindling account.
Later, you spend most of the night staring at the ceiling, unable to sleep.
You wonder…will you now have to work until you’re 80 years old? What about that dream vacation home? By the time the sun has risen, you’ve made up your mind. You cannot bear to see any more losses in your account and plan to sell as soon as the market opens Monday morning.
For many of us, the roller coaster ride that is the stock market can be harrowing. But it does not need to be that way. Let’s look at some of the ways to manage your emotions during volatile market conditions.
Take a step back and revisit your portfolio goals, which should be the foundation of your investment strategy.
Some goals may be short term, while others may deal with the far-off future. Your investing strategy to fund short-term goals (like paying for next year’s vacation or remodeling project) will probably be different from the strategy you use for longer-term goals (like covering your needs in retirement 15 to 20 years out).
Some investors find it helpful to set up different accounts for different goals (or sets of goals that are similar in terms of timing), as opposed to having a single investment account to fund all goals.
Determine if current market conditions dictate the need for changes so that your portfolio can stay aligned with your goals. Any changes that are made should be consistent with your personal financial goals. Sometimes, the best decision is to stay the course and ride out the storm.
Investors can make emotionally charged decisions that only serve to make matters worse. It is easy to buy at market peaks when it seems as though nothing can go wrong — and just as easy to sell at market bottoms when there appears to be no recovery in sight.
When we try to time the market (i.e., attempt to buy when the markets are low and sell when the markets are high), the consequences can be devastating.
A recent Bank of America study concluded that missing out on the 10 best stock market days of each decade dating back to the 1930s would have cost an investor a total return difference of more than 14,000%.
It is extremely difficult (if not impossible) to accurately call the “true low” or “true high” of any market cycle while it’s happening. So, even if someone could look at market charts in retrospect and explain why the curve bounced up or dropped down at any given moment in the past, things are a lot less certain in the moment. Therefore, there is a real risk of missing the window of opportunity by waiting for a “higher” high or a “lower” low.
This is why many advisors recommend “dollar cost averaging,” which means investing in the markets steadily over time in alignment with your earnings and financial plan. If your projections suggest you are still on track to meet your goals, then it may be best to leave things as they are. If not, an adjustment to your asset allocation or to certain holdings may be appropriate.
Volatile market environments can be viewed as an opportunity to reassess your risk tolerance. Perhaps you’ve taken on more risk than you realized and it’s time to revisit your risk profile. Maybe you’re not taking on enough risk and there are opportunities on which you can capitalize.
Remember, your risk tolerance is a combination of your willingness to accept risk and your ability to accept risk. The two are not the same. For example, someone may be eager to take higher risks with investing — but unable to do so because it would compromise their personal financial needs.
You could also have an opposite scenario. A different investor may be able to afford more risk in their portfolio — but hesitant to do so because it could lead to a level of financial worry that would negatively affect their quality of life.
Therefore, an honest evaluation of your exposures in the context of your personal financial situation and goals is prudent.
Just as there are cycles to the economy and the capital markets, there is also a cycle related to our emotions. Investors can experience a wide range of emotions over the course of their investing lifetimes. We can feel euphoric when markets are rising, despondent when markets are falling, and everything in between.
At the various phases of the emotional cycle, we are susceptible to making decisions based on feelings rather than sound judgment. Whether your emotions are at the top or bottom of the cycle or somewhere in between, it is important to be conscious of what feelings you are experiencing — and how those feelings can impact your financial decision-making.
When it comes to managing emotions, investors can benefit from working with a professional advisor. Your advisor has a working knowledge of both the market cycles and investor psychology. They can help you define your goals, assess your risk tolerance, and put the roller coaster ride into perspective.
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