How do we manage our emotions?
Investing is challenging. It brings out the worst in us. When the market is running, we just want more. And when the market goes down we’re tempted to sell just when things are bottoming out. It’s been shown that money goes into and out of mutual funds following the market. As a result, these investors typically underperform their funds by a lot—often by two to three percent. Three percent may not seem like much, but over time it really adds up. An 8% return grows five-fold in 20 years; 5% grows about half that much.
So how do we discipline ourselves so we don’t bail out at the bottom? One approach is to forget about it. Take the statements and file them away without opening them. That can work if your investments are on auto-pilot and don’t need regular oversight. A lot of folks with retirement accounts are in this category. But if you want or need to adjust your portfolio for any reason, you can’t do this. Besides, most of us are at least curious to look inside the envelope.
So for most of us, the first step in managing our emotions is to acknowledge them. Money invokes emotions. When you see your account balance go down by a lot, it’s emotionally jarring. It should be. No one—with the exception of some European institutions—invests with the intention of losing money. But we all know markets fluctuate. We’re just not ready for it.
And that’s the next step: be ready. Hope for the best, but imagine the worst. When we see a storm coming, we prepare. It’s the same with our money. Take the investment totals on your statement, cross them out, and pencil in a number 25% lower for stocks and 10% lower for long-term bonds. Add those that up, along with your cash. That could be your balance next year. Your advisor may talk about the upside possibilities, but you should try to simulate what a downturn in both stocks and bonds would feel like. If you think that total would keep you up at night, sell down to your sleep-point, and hold the balance in short-term bonds.
Source: Climate Central
Finally, make a plan. Bill Gross has written about his reaction to Black Monday in 1987: he didn’t do anything. Even though he knew that an immense stock market crash meant a substantially weaker economy—at a time when the Fed had been tightening—he didn’t buy any bonds. The plummeting market hypnotized him, and he missed out on one of the biggest fixed income rallies ever. Think through how to react to a downturn. No one plans to fail; many just fail to plan.
We can manage our emotions by acknowledging, imagining, and planning out a rational response to volatile markets. As a Chinese sage once wrote, understanding others is wisdom; understanding ourselves is enlightenment.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!