Many factors can inform investment decisions: Financial goals, asset allocation and diversification strategies, tax benefits and indirectly, how investors feel about the market. It’s this last factor that you can control most closely.
When a market is in an upswing, investors sometimes believe it has nowhere to go but up. They may even start to feel euphoric, and that euphoria can lead to making investments when markets are overheated. However good the feeling, though, those might be better times to hold or sell.
“We certainly saw that just before the financial crisis in 2007,” says Rob Haworth, senior investment strategist for U.S. Bank. “In the housing market, houses would turn over within weeks because people believed in the inevitability of housing price gains and perhaps magnificent housing price gains.”
That euphoric feeling is at one end of the emotional spectrum for investors, based on a common cycle of investor emotions. At the other end is despondency, which can cause investors to foresee only further declines in the market and pull back — or even exit markets — not realizing that it could be an opportune time to buy.
Market volatility depends on many factors, and it will never disappear. So it’s essential for investors to understand how to manage their emotions in the face of volatility. Four steps are key.
1. Learn about economic cycles. To reduce the impact of emotions on your investment decisions, consider how similar economic cycles have unfolded in the past, both in the United States and international markets. As part of your knowledge finding, also research long-term investment strategies and methods to help mitigate risk. “People often like to say, ‘This time is different,’” says Haworth. “History may not repeat exactly, but it does rhyme, and that’s true with markets.”
2. Stick to your plan. Base decisions on your long-term goals and don’t be swayed by the daily markets. Are you saving for retirement? A large purchase? Your child’s education? That goal will determine your asset allocation strategy and time horizon. That initial strategy you established should account for normal market volatility, so turn off the news and focus on the long term. Be sure to check in on the progress in your portfolio at least annually, and review your plan whenever you have a major change in your life.
3. Diversify your holdings. To reduce risk and account for volatile markets, your portfolio should include investments that have higher returns in different scenarios. For example, technology company stocks may do well when the economy is booming but not during a downturn. On the other hand, consumer-staple companies that sell everyday goods such as toiletries and food usually offer solid returns even in a recession. Fixed-income investments, such as bonds, generally have steadier returns than stocks.
4. Expect — and accept — volatility. Rather than attempting to time the market, focus on time in the market. While past performance is not a guarantee of future results, investors with diversified portfolios who stay in the market have historically and consistently experienced steady gains over time. “The hardest part about choosing when to be in or out of the market, and we see this in the data all the time, is that missing a few months of a five- or ten-year cycle can completely decimate an investor’s return,” says Haworth. “The pattern of returns is simply not predictable from month to month, so keeping a consistent investment can add to the bottom line.”
A wealth management professional can offer a much-needed outside perspective when your emotions are running high. They may also guide you on potential ways to go beyond just surviving volatility, such as:
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