No matter how or where you invest, there will always be times when the market doesn’t cooperate. Periods of stress are a natural part of the investing cycle, but you can prepare for them so that when the next big market crash occurs, you aren’t a total basket case.
The problem with emotions
Emotions have an important place in our lives, but they can create serious problems if you let them get in the way of your investing habits. Knee-jerk reactions to news headlines can make a difficult situation even worse because instead of making a wise decision, you made a move based on how you feel at a particular moment.
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According to a Morningstar study, investors who avoid panicking see a net increase of 17% to 23% in their assets over a decade's time. That's quite a significant increase—all from simply not letting stress drive your investing decisions.
Emotions can impact what we buy or sell and the timing of these trades. Fear is a constant driving motivator for some investors. They may worry about missing out, so they dive into a stock that has simply gotten too expensive because they have a fear of missing out.
On the other hand, they may worry when the market crashes, so they might sell out of a stock after it plunges because they're afraid of it falling further. The better course of action is often to wait it out because stock prices generally go back up unless there is some company-specific reason for their plunge.
Another powerful emotional motivator is euphoria, which occurs when investors keep buying a stock that has already risen far beyond where it should be. Hedge fund managers like Lee Ainslie have warned about market euphoria as recently as a year ago. Ainslie, who runs Maverick Capital, said in one of his investor letters last year that he believed market euphoria had reached heights not seen since the dotcom bubble.
Some investors become emotionally attached to a particular investment. They become unwilling to let it go even though hard data and facts suggest that the stock will probably never go up again.
How to mitigate emotional investing
Because investors tend to lose a lot of money by having knee-jerk reactions to news headlines, one of the simplest ways to avoid that is to spend less time reading the financial news media. You won't be able to totally avoid hearing about what's happening in the market, but you will be able to eliminate some of the noise that contributes to those knee-jerk reactions.
It's also a good idea to have much of your portfolio in investments that can be set and then left. You won't have to spend as much time studying the financial media if you have a diversified portfolio of investments that increase in value much of the time.
Some investors use what's called the bucket approach to manage their investments. It involves dividing your portfolio into money you'll use in the next 10 years and money that will be used after 10 years. The money that will be needed in the next 10 years is then invested into fixed-income investments like cash, dividend stocks or bonds. During times when the broader market declines, fixed-income portfolios may be flat to up a bit. Having the money you will need for the next 10 years in assets that will almost never decline steeply in value removes the stress of day-to-day investing.
Surviving market stress the rest of the time
No matter what you do with your portfolio, there will always be stress to manage. Even if you can avoid making decisions based on panic or emotions, you've still got to find a way to deal with the stress of watching your portfolio tank, even if it's the money you don't need right away.
Some of the most common stress management techniques simply don't work when it comes to market stress. For example, thinking positively is impossible to do when the sky is falling. Just taking up a more positive attitude won't change what the market is doing.
Since you can't change what the market does, you should focus on changing your reactions to what it does. Relaxation techniques can go a long way toward being able to think about what's happening in the market without losing your head over it. Meditation, tai chi and yoga are all excellent ways to calm your mind down when things start to move sideways.