Emotions have run high this year In Libertyville, IL, and beyond. The U.S. has faced a major global pandemic, choppy economic times, plummeting equities earlier in the year, and then new highs and contentious political times.
All of these factors and more may cause investors in Libertyville to give in to emotional investing. Emotional investing is driven purely by your feelings of anxiety (or, conversely, anticipation for more positive scenarios) and not by rational thought.
Emotional investing can lead you to abruptly sell equities that have plummeted. Or it can lead you to chase the next big thing (such as the COVID-19 vaccines announced in the fall of 2020).
The problem, however, is that emotional investing is seldom a good idea for your investment portfolios. A sound, well-thought-out plan that accounts for your goals, age, and lifestyle should drive your investment decisions.
Let’s say you sell equities because the market falls significantly. You’ve avoided one risk (a further market decline), only to incur another one. You’ve lost the chance to regain your money when prices rise again.
We all have emotions, of course. A 20 percent (or more) market decline in the span of a few weeks can’t help but make most investors anxious.
The key is to feel your emotions, but not let them rule your investment behavior. You also can benefit by working with a financial advisor to set up an investment policy statement. This written plan helps make sure you’re taking the appropriate amount of risk. As well, during times of heightened emotion, it’s a reminder of your long-term objectives, so you take (or don’t take!) suitable action steps when feeling uncertain.
How To Avoid Emotional Investing
Here’s a to-do list for avoiding emotional investing:
1. Allocate your portfolio assets properly
Both your investment and retirement portfolios should be invested using an asset allocation strategy that maximizes your portfolio growth AND protects against market volatility. However, investing for growth involves taking on risk, and every investor has a different comfort level. Therefore, striking this balance is an integral part of stock market investing.
Equities typically offer the highest average annual return of any asset class – roughly 10 percent a year, on average, over the last near-century. But because equity prices can drop, investors can also lose money in the short term.
To counterbalance that risk, a certain percentage of your portfolio should be placed in bonds or cash instruments. Bonds and cash offer high stability of principal. You don’t want the percentage devoted to bonds/cash to rise too high, though, because these two asset classes also have a drawback. The interest rates on both are at historically low levels.
Every investor has a different comfort level with risk, and as well differing needs for growth in their investments. Typically, younger investors have higher risk capacity since, in theory, they have many years to allow their nest eggs to grow. Conversely, an older investor is likely closer to retirement and may have a lower capacity for risk. These situations are not always gospel – as an example, a younger person may have capital needs (such as purchasing a home), and it might not be appropriate to take on substantial risk with every dollar saved. Therefore, it’s important to discuss your situation with a financial professional
2. Diversify, diversify, diversify
Remember the old saying “don’t put all your eggs in one basket”? It’s tailor-made for stock market investing!
You need to diversify the equities you purchase by sector and geography. Your asset allocation strategy should also diversify your bonds and cash instruments.
Tough economic times can exert pressure on specific sectors. During the pandemic, for example, airlines have not done well. Diversification among sectors can help ease any blow.
If you are a small business owner, your investment and retirement portfolios should diversify beyond the sector in which your business operates. Why? Because if your business has to downsize or even goes under due to economic conditions, your personal assets shouldn’t be positioned to feel pressure from the same forces. Again, diversify given your situation.
3. Utilize dollar-cost averaging
While falling stock markets can seem to erase money, they actually have certain benefits. Declining markets make equities cheaper! A $100/share equity that falls to $65 may seem like a scary spectacle to those that hold it, but not to the eager investor snapping it up at the new, lower price! It’s a buying opportunity.
You can protect yourself from stock market volatility by utilizing a strategy called dollar-cost averaging. You set up a given dollar amount every month to purchase securities, no matter what the overall market lands.
Dollar cost averaging protects you from buying only at high prices because you purchase securities steadily, at all levels. The steadiness of your deposits makes it highly likely you will purchase during periods when the market is falling.
This strategy is frequently used in 401(k) plans, when you save a little bit for retirement from each paycheck. If you don’t have access to a 401(k) through your employer (or want to save beyond solely that program) contact your financial advisor for guidance on how to set up an ongoing savings strategy.
4. Review your portfolios periodically
All investment and retirement portfolios should be reviewed periodically between you and your financial advisor. Consider any changes in asset allocation, strategy or goals at that review meeting.
At the end of the year, portfolios should be rebalanced to maintain the ideal asset allocation. A period of rising or falling stock market returns can overweight or underweight you; rebalancing rectifies that shift.
5. Manage your emotions
It’s always good to have specific methods of managing emotional investing. While 2020 has been one for the record books, periods that stoke emotional investing are sure to come again.
First, never make decisions regarding your financial plan immediately. Always sleep on any decision before executing it.
Second, discuss your plans with a financial advisor. Financial advisors can offer insight and ideas to sooth your mind and maximize your financial plan.
Third, remember history. From the Great Depression of the 1930s to the Great Recession of 2008, investors have weathered financial storms, including periods of high unemployment and major market declines. Each time, we have recovered.
Fourth, work with a CERTIFIED FINANCIAL PLANNER™ Professional to develop a comprehensive financial plan that meets your life goals. CFP®s have specific experience and qualifications that ensure they can provide balanced advice to retirees, pre-retirees and business owners.
At Prism Planning Partners, we are CERTIFIED FINANCIAL PLANNER™ professionals committed to facilitating your important questions so that we can help you explore all of your many opportunities. We offer a broad array of financial planning and consulting services for our clients-including estate planning.
Contact us today to re-evaluate your financial plans so minimize any negative effects of COVID-19 and set you and your family up for long-term recovery.