Getting out of your own way
In the end, it’s not bear markets that get you. Or inflation, or higher taxes, or recessions either. Nope. The biggest threat we face as investors is the one staring back at us in the mirror.
It’s the critical decisions you make, especially at market extremes, that impact your real-life investment returns more than any other factor. It’s deciding to buy something simply because it seems to be going up in price every day, or because everyone else you know is buying it, or because you’re simply afraid of missing out.
During the 2007-09 global financial crisis, it was deciding – after 17 months of falling stock prices and growing economic despair – that you’d had enough. The voice in the back of your head was warning you that if you didn’t sell immediately and preserve what was left of your portfolio, that you would never get another chance.
If you recognize yourself anywhere in the preceding two paragraphs, you are not alone and you shouldn’t feel bad about it. You are a human being, and though blessed with intellect and experience, humans still tend to ignore both when making important decisions under pressure. Humans are emotional creatures, and emotions typically do more harm than good when it comes to investing. We just can’t stay out of our own way sometimes.
DALBAR, a financial research organization, conducts a study each year that compares the results investors have achieved over the prior 20 years with the performance of major market indexes. You might assume that investors, on average, would get returns that are pretty close to market averages. But year after year, in study after study, we consistently fall short.
Somehow, investors repeatedly and significantly underperform their own investments.
Researchers have been trying to find out why this happens. In fact, there’s an entire field of academics devoted to the study of “behavioral finance” that has uncovered a number of behavioral biases that lead us to making these mistakes over and over again.
As financial advisors, my team and I recognize that helping clients with their behaviors is just as important as helping them with their investments. We accept that all investments carry some form of risk, but trying to avoid those risks at all costs typically leads to disappointing results over the long term.
Instead of hiding from an uncertain future, we try to plan for it with a three-step process:
- Acknowledge the facts. While history tells us that owning equities gives us the potential for greater returns, it also means short-term volatility and scary downturns from time to time. Bad markets happen.
- Anticipate how you will likely feel when it does. Watching your portfolio decline in value – even temporarily – can be frightening, disorienting, and painful. Accept that you will feel that way; it’s only human. The key is what – if anything – you will do when the next inevitable downturn occurs.
- Decide now how you will react. When I helped coach our son’s Little League team, we taught each player to tell himself before every pitch exactly what he would do if the ball is hit to him. “Catch the ball. Check the runner. Throw to first.” Create a financial plan that assumes setbacks along the way while still directing you toward your long-term goals. And then be ready for the next pitch.
Always remember that it’s okay to feel emotional when things don’t go your way. It’s acting on those feelings that often get us into trouble. And the time to decide how to handle adversity is when you aren’t facing any.
Any opinions are those of Mike Brown Financial Group and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Investing involves risk and you may incur a profit or loss regardless of strategy selected.