When we’re fortunate enough to experience extra-long period of good times in the market, this can cause two reactions in people. People who have invested for some time and have some understanding of the markets start to get a little nervous. People who have been reticent to start investing begin feeling like they are missing out. This FOMO causes them to jump in with both feet, and invariably, they freak out at the first market down turn.
So, what is a good investor to do? Invest it and forget it. At least mostly forget it. If you are investing regularly now, whether in your company retirement plan or elsewhere, carry on. We cannot time the market. Instead, make sure you have diversification in your portfolio, and make sure that you have addressed your risk tolerance. Let me elaborate.
If you are the sort who watches the market movements with fear and trepidation, it is likely you don’t have much risk tolerance. If, however, you can move along with your life while your investments do their work, and if you don’t fret market downturns, you probably have decent risk tolerance. Measuring your risk tolerance can be a bit more scientific, including online investment websites with analytical risk tolerance quizzes. But in my opinion, determining risk tolerance is more of an art than a science.
The level of risk you choose for your portfolio should be based on goals and your timeline. The farther you are from the goal, the riskier you can afford to be with your investments. If you are parking money for a shorter-term goal, such as buying a home in a few years, your portfolio should reflect much less risk in your investment selection. However, layered on top of time and goals is the “art” part. The “gut” part. Know thyself. If you freak out about market movements, make your portfolio less risky, even if you have a 30-year time horizon for your portfolio.
There is plenty of evidence out there proving that investors screw themselves over because they dismantle a perfectly good portfolio at the first sign of market downturns. And by doing so, they lock in the exact opposite phenomenon of successful investors. Instead of buying low, selling high, a “freak-out,” or knee-jerk reaction, causes you to sell low, and then when you see the market improving, you buy back in high.
This is the main reason financial advisors are so important to clients – we talk them off the cliff before they jump. We protect you from yourself, because we understand that markets go up AND down. Thus, it is best to invest it and forget it. The more you worry over it and watch it move every day, the more anxious and stressed you will become. If you have a rock-solid gut (i.e. excellent risk tolerance) and you ENJOY watching the market gyrations, then bully for you – have at it. Again, KNOW THYSELF. If it makes you nervous, stop watching it!
A caveat here: I said “mostly” forget it. This is because after you establish your risk tolerance and choose an appropriate diversification (aka asset allocation), you should periodically rebalance your allocation. For example, if you decide that having 50% of your portfolio in stock investments is all you can handle risk-wise, and the other 50% is invested in more conservative bond and cash investments, you will want to adjust it after the stock market has an awesome year. If, let’s say, the market goes crazy up and now your portfolio sits at 60% stock and 40% bonds/cash, you would sell off 10% of your stock investments and purchase more on the other side to get yourself back to 50/50.
For rebalancing, it is best to be totally clinical about it. DO NOT let emotions drive your behavior, or you will screw up. If you decide that every September (or January, or June – the month doesn’t matter) you will rebalance, then DO IT. Just because you look and your account is doing completely fantastical things due to the market, so maybe just this once you will let it ride for a few more months, DON’T DO IT. Decide in advance when you’ll rebalance and then DO IT.
There is an old Wall Street saying that I don’t particularly like, but it is apt: “Bulls make money, Bears make money, Pigs get slaughtered.” The point is that greed will get you killed in the market. Therefore, rebalance your portfolio regularly, regardless of what is going on in the market. And don’t freak out and sell it all when the market tanks. Markets go up and down. Remember that and then go pay attention to something else.
What do YOU do to cope with market nerves? Are you willing to share a story of a time you lost your nerve in the market? Share your strategies and stories!