It’s easy to succumb to the urge to sell if the market takes a header or buy if it’s headed upward. But sudden action is usually a mistake. In the late 1980s, Harvard psychologist Paul Andreassen made news with a research project that found that people who listened to market news actually made lower returns. Why? Because those who sold – or bought – during a market swing probably found a day later that the market was really running on hype, not fundamentals.
You pay a financial planner to devise a financial strategy that matches your risk tolerance and long-term financial goals. There is no way to guarantee that you’ll never lose money. But if a plan truly matches your goals, values, and abilities, the noise level on TV shouldn’t make a difference. So the next time the Dow spikes or slides, ask yourself:
What’s my plan? If you have a good financial plan, you should be able to articulate those goals or refer to an investment policy statement you made together with your advisor. Much of the riskiest investing, overbuying and panic selling during the late 1990s and early 2000s could have been avoided if individual investors had sought advice for achieving long-term specific goals such as retirement or a college education.
What’s my risk tolerance? Most people understand that the riskier an investment, the greater the expected return should be. Higher returns are nice, but if you don’t have the stomach for the big up and down swings that usually come with riskier investments, you may get out at the worst possible time. Instead of buying low and selling high, you’re doing the exact opposite. You are much better off to stick to investments that will allow you to sleep at night, allowing you to stick to your plan. Markets go up and markets go down and you need to find an investment mix that matches your risk tolerancel and that will allow you to stay the course.
Am I prepared to stay invested – no matter what? We all remember the “Tech Wreck” of 2000. At the worst of that downturn, investors bailed out of the stock market or drastically cut back, only to get back in after they were “convinced” that the market was rebounding. In reality, they missed out on stock market gains during the early stages of recovery, and that can be costly in the long run.
In 2004, SEI Investments studied 12 bear markets since World War II. Investors who either stayed in the market through its bottom, or were fortunate to enter at the bottom, saw the S&P 500 gain an average of 32.5 percent (not counting dividends) during the first year of recovery. Investors who missed even just the first week of recovery saw their gains that first year slide to 24.3 percent. Those who waited three months before getting back in gained only 14.8 percent. The message here is clear; investing in the markets is a long term strategy, and bouncing in and out, can significantly impact your returns.
Am I diversified? With so many asset classes suffering losses in the last year, I’ve heard some discussion suggesting that a diversified portfolio may no longer be a good thing. I find it interesting that no one thought diversification was a bad thing a couple of years ago when most asset classes were rising. I remain convinced that over the long term, and through all kinds of different markets, the concept of not having all of your eggs in one basket remains an important one. Because no one can accurately and consistently predict the future, spreading your investments around multiple asset classes will reduce the overall ups and downs in your portfolio, making it easier to stay the course and keep you on track to achieving your goals.
Do I still feel the same way I used to about returns? Having a long-term investment plan doesn’t mean make the plan and leave it to gather dust. The reality is things change. You should periodically review your investment goals and your feelings about them. Annual reviews makes sense if nothing’s going on, but life events like death, divorce, kids moving out and illness are good reasons to do a head-to-toe review of a financial plan. Changes in your situation and goals are the reason changes should be made to a financial plan, not market volatility.
This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Meritage Wealth Advisory, a local member of FPA.