Markets, Retirement

Do Not Let Emotions Influence Your Investment Decisions

8/2/17 8:00 AM

iStock_000018447826_Small-1-1.jpgThe post-election run-up in equities has continued in 2017, and major stock market indices are now at or near record levels. Some traders, though, have grown concerned that stocks have risen a bit too high too fast, and that a correction should therefore be expected. Predicting where equities will head over a short time horizon, though, is extremely difficult if not impossible. More importantly, retirement-focused investors should not obsess over the day-to-day fluctuations in stock valuations because selloffs are far from uncommon.

The S&P 500 since 1980, for instance, has experienced an average intra-year drawdown of 14.2 percent but still posted a positive annual return for 28 of the past 37 years. Even if stocks do wind up experiencing a big correction in the near-future, it could actually be healthy for the market because it would make it easier (cheaper) for individuals that remained on the sidelines (in cash) and missed out on the earlier equity run-up to finally step in and participate. To put this another way, long-term participation in the market can provide investors with more opportunities to capitalize on selloffs by purchasing shares at a discount.

Something else that can help investors during the inevitable periods of heightened volatility is the ability to refrain from panicking. Indeed, it is generally not a good idea to make any kind of decision based on emotion and this is especially true for investing. However, it is not always easy for retail investors to keep emotions out of their decision-making process. This was likely the case for any market participants that turned on the television one Monday morning in the summer of 2015 and saw the Dow Jones Industrial Average open down by 1,000 points.

The recent all-time highs reached in the stock market demonstrate that panicking during that scary but short-lived crash was probably not a great idea. Many investors may even understand that they should not let emotions drive their investment decisions but there are still scenarios where they could wind up acting too hastily. For example, market participants near the age of retirement are likely to become very nervous during a correction as they watch their nest-egg rapidly plunge in value. Moreover, many older Americans during the 2008 financial crisis probably believed that they were doing the right thing by dumping their stock holdings as prices tumbled.

For these individuals, though, their problems were likely exacerbated not just by panic selling but also by having an elevated exposure to the stock market at such a stage in their life. Indeed, the closer investors get to the age of retirement, the smaller their equity holdings should be. If the bulk of their investments are in more conservative assets, e.g. bonds and cash-like instruments, then it should be a lot easier for them to avoid making emotional decisions during a stock market selloff since the portion of their portfolio that is exposed to equities is relatively small.

Of course, risk can never be completely eliminated from a portfolio but it is possible for people to better manage their overall sensitivity to adverse price swings. While the process can seem quite complicated for many retail investors, consulting with a financial advisor can often provide a lot of help. In fact, a survey by Charles Schwab found that nearly three-quarters (74 percent) of 401(k) participants who said that they regularly work with an advisor reported being “extremely or very confident” in their ability to make the right investment decisions for their retirement plan, compared to just 44 percent for respondents who do not seek professional advice.



Sources: Yahoo Finance, New York Times, J.P. Morgan, Charles Schwab

Post author: Charles Couch