Investors are fickle. Investing should not be.
Even with a brilliant investment plan, it takes diligence to overcome emotional biases and avoid making investing mistakes. Naturally you love it when your portfolio values go up. But when they go down, even slightly, you may be tempted to make poor choices.
Here are some reminders to help you resist succumbing to the fallacies of behavioral economics.
Psychologists suggest we feel a loss about 2.5 times as much as an equivalent gain. This "loss aversion" phenomenon means that even when we see an equal number of ups and downs, we still feel miserable.
Daily market movements are nearly always noise. Only 52 percent of daily movements are positive. Because the negatives feel worse, your average day could feel 68 percent negative.
Quarterly odds of satisfaction are 62 percent, but they still feel 13 percent negative. But if you discipline yourself to look at annual numbers, you get 77 percent odds of happiness, and when you analyze 3-year, 5-year, or since-inception returns on your reports, it will make you even happier.
You may have believed you had a high risk tolerance when the markets were going up, only to regret being in when they went down. You also remember your uneasy feelings just before the markets dropped and forgot you had the same ones just before the markets went up.
All this leads to a false confidence in your own ability to predict what will actually happen and possibly a weakening confidence in your financial advisor's skills to see the obvious.
Research repeatedly shows that jumping in and out of the markets reduces returns. But some people persist in believing that if they just had enough information, they could predict what, in reality, only seems obvious after the fact.
Remember to ignore daily financial information. Most so-called news is just noise; we call it financial pornography, which includes everything from CNBC to the nightly news.
The markets are inherently volatile, but until recently they have been well behaved. Between 2004 and 2006, the S&P 500 moved up or down by more than 2 percent on only two days. Since mid-2007, we have had 27 days over 2 percent, and market volatility has returned to historical averages.
Between 2004 and 2006, the S&P 500 moved a daily average of only 0.51 percent compared with a historical average of 0.75 percent. Since mid-2007, volatility has been slightly above average at 0.99 percent. You must remember that such volatility is normal.
Every January 1, sometime during the coming year we will have a foot of snow in a week, 6 inches of rain in another week, and a 5 percent to 10 percent market drop in one month. It is almost beyond commonplace. But the snow always melts, the rain dries up, and the equity market resumes its great long-term uptrend.
The markets are inherently volatile but also inherently profitable. It is prudent to diversify for safety and stay invested for long-term growth.
So although we don't know the markets won't go lower (no one does), don't let your short-term emotions trump an effective long-term strategy. Remember that strong long-term investment returns do help, but the best way to achieve your financial goals is to moderate spending and stay on track with savings.
David J. Marotta is president of Marotta Asset Management, Inc. of Charlottesville which provides fee-only financial planning and wealth management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to questions at emarotta dot com or Marotta Asset Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903-4619.
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