Understand how the ups and downs of investing can alter your financial judgement.
Investing, if you think about it, is really an act of optimism, of hope that your money will grow over time. But there will be times when optimism wanes as the markets ebb and flow through a full cycle, and you may need to temper it with pragmatism and trusted counsel as the vagaries of the markets play with your emotions. Dive into the four stages of investing to see what we mean:
First Stage: The Thrill
It’s behavioral finance 101. We believe in ourselves; we expect things to go our way. When they do, it confirms our confidence, which feeds expectations of even greater success down the road. Thrilling!
It’s at the top of a cycle when we feel the most positive – euphoric even. But guess what? When we start to believe that outsized returns justify higher levels of risk is when we’re most vulnerable to financial jeopardy. No one, not even the best market prognosticator, has a crystal ball or the Midas touch. We can’t always beat the markets, and we will make mistakes.
Second Stage: The Lull
Eventually, we realize that we may not have as much influence as we first thought. The markets no longer return double digits, and we seek any sign – whether accurate or not – that will point us in the right direction. Anxiety mounts, maybe a little uncertainty sneaks in.
You may “instinctively” feel you should become more cautious in your financial plan, trading assets you perceive to be riskier for bonds or other defensive asset classes. Not a bad idea if done in conjunction with your advisor, who understands your risk tolerance and desire to preserve wealth.
A note about the current environment:
As the Federal Reserve has both increased and decreased short-term interest rates over the last twelve months, you may be concerned about fluctuations in short-term bond prices. Keep in mind, however, that individual bonds may provide income and offset volatility in the equity side of your portfolio. Sticking to your long-term strategic asset allocation is likely the most prudent approach. Don’t give up on equities, either. Even when it feels like you’re on shaky investment ground, you may still be able to find pockets of opportunity.
Third Stage: The Potential
When bear markets come roaring through, you may feel panic or desperation, and hope to spare yourself any further losses by sitting idly on the sidelines until you’re “ready” to try again. The irony is this stage is when investments are typically lower in price – and when a well-prepared investor has the maximum potential to capitalize on financial opportunity. Remember 2008? Some investors got out completely and missed out on the subsequent recovery. It’s important to work with your advisor and periodically review your tolerance for market risk to help ensure your portfolio is positioned appropriately.
Last Stage: The Upswing
You’ve just been through the emotional ringer, and now, somewhat incredulously, the markets are back on the road to recovery. But you’ve been burned; you don’t quite trust that this rise will last. So you may opt to lick your wounds instead of recognizing that asset prices are still low and there are attractive opportunities to be had, if you focus on the fundamentals. The need to invest – for your retirement, your children’s education, your legacy goals and other personal objectives – isn’t going away. Investing intelligently – having a plan, knowing what you own and why – may just be your best option.
Having a clear understanding of why you’re in the market and what you want your financial plan to do makes it much easier to remain disciplined. That’s why it’s important to revisit and reaffirm your personal goals and time horizon with your financial advisor. You’re investing in order to achieve certain objectives – the decisions you make should rest on that foundation.