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The decisions you make as an investor during stock market highs and lows -- time periods that are often characterized by either irrational exuberance or despondency -- are arguably your most important investment decisions.
And with 2016 off to a rocky start for investors, you may well be asking yourself, “What do I do now?”
As an adviser, I tend to talk to my clients more often during times of turbulence. We do discuss the probability of different market moves, although I find it less useful to predict specific outcomes; over longer periods of time, investments tend to recover and move on. Rather, I hope that increased communication and planning will help my clients participate in any market recovery to come.
Many of our conversations focus on avoiding these three behavior pitfalls -- what I think of as "down-market don'ts."
1. Don’t Just Bail
If you’re like most people, your brain is wired to feel more pain from losses than pleasure from market gains. This loss aversion can result in an impulse to stop the pain by ditching investments. The desire to avoid more losses and, therefore, more emotional pain grows stronger as markets decline further. If you need money during a downturn, evaluate your options carefully – but for anything else, avoid panicking.
2. Don’t Check Out
Big swings can lead to investor paralysis. Some people manage to avoid selling, only to then walk away from the responsibility of investment decisions. Some people stop contributing to retirement plans or quit managing their investments altogether; I have met people who checked out for several years after the Great Recession. Don’t let the stress of turbulent markets knock you off your game.
3. Don’t Wallow
Even if you can stand your ground, be on guard: Many investors succumb to extreme pessimism during market meltdowns. Some gloominess may be justified, but be aware that your feelings may be magnified by something called recency bias: when your mind magnifies recent patterns and believes that a continuation is the only option going forward. That's why investors feel exuberant at market tops; it's also why at times of turmoil, better times seem unlikely. Remind yourself that, over the long run, markets tend to be cyclical.