For an investor, one of the most vital forms of social distancing during tumultuous markets is to keep lots of room between your decision-making and your deep-seated financial fears and instincts. It’s not easy. You are repeatedly buffeted by anxiety, hope and despair. And your portfolio constantly seems in danger of being thrown off-track.
Among the biggest challenges is to avoid giving in to extreme and often contradictory urges. Bottom Line Personal asked behavioral finance psychologist Frank Murtha, PhD, how investors can protect themselves from their own worst impulses…face the reality of what’s happening without panicking…and come out of all the market turmoil in good financial shape…
First, here’s a summary of some of the most damaging and extreme behaviors that lead investors astray, followed by advice on how to prevent those behaviors from wrecking your long-term financial plans…
Avoid These Behaviors
Paralysis or hyperactivity. Either you avoid looking at your investment accounts altogether…or you check them too often and tamper with them too much.
Selling on slides…buying on rallies. You become emotionally reactive, exiting at the worst time, when your investments have plunged…and/or jumping in after the market has soared.
Ignoring your plan…or abandoning it. You take actions that contradict your long-term investment plan…or you alter the plan unnecessarily.
To avoid going astray, you must keep in mind what your goals are and how you have planned to achieve them.
Establish Guardrails
I tell my clients to set up some investment “guardrails” that will keep them on track and buffer any emotions that could undermine their long-term plans. Six valuable guardrails…
Record a short video of yourself explaining your long-term investment plan. It should cover how much you allocate to stocks and bonds and why…your tolerance for risk…and your time horizon. Many advisers recommend writing down that plan and reading it in tough times. But that’s not always enough to provide the self-discipline you need. It’s very powerful to hear and see yourself speak. Talk directly to yourself in the video, and say something like, “The stock market may not recover for a long time, and you’re wavering. But you knew this day would come. You can handle this storm because you have a solid, well-thought-out plan and promised to stick to it no matter what. You should be able to weather temporary setbacks and have years for your portfolio to recover. Understand that your discomfort now is the price you pay for long-term wealth.”
Make it a hassle to check your investment portfolio obsessively. Checking multiple times a day or even every day puts you on an emotional roller coaster and increases the likelihood that you will engage in self-destructive panic trading. You can mitigate this compulsive checking by making it slightly harder to access your account online. Example: I have had clients who deleted the brokerage app from their smartphones…who elected not to save their passwords on the brokerage site, forcing them to reenter it each time…and who opted for two-step security verification so that each log-in requires that they receive and input an additional code.
Hide the cost basis of your investments from view when you do check your account online. Many investment websites show you how your investment has performed over various periods…and how it’s performing compared with the overall market now. Seeing this data triggers what’s known as an “anchoring effect.” You focus on arbitrary short-term numerical values that could cause you to react too negatively at the expense of your long-term objectives. A stock doesn’t care what price you bought it at. What matters is whether you still want to own the stock at the price on your screen considering its current potential for gains. Of course, you may want to consider what effect selling an investment in a taxable account will have on your taxes. But that shouldn’t be the primary consideration in deciding whether to sell a stock.
Invest in baby steps. Many investors in the current crisis feel that they must make perfect market-timing decisions or not do anything at all, which often leads to paralysis. For example, some of my clients have stopped adding money to their 401(k) plans until they feel certain that the market has hit rock bottom. Others no longer believe in a particular stock they own, but they hang on, hoping that it will rise a bit so that the eventual loss they take won’t be so bad. This kind of all-or-nothing approach greatly increases risk and leads to paralysis as you second-guess yourself. Better: Aim to make good decisions rather than great ones by acting very systematically. For instance, instead of trying to guess how low the market will go, simply dollar-cost average, spacing out your investment purchases by adding money at regular intervals and in equal amounts. That way, if stocks keep falling, you’re buying shares at cheaper and cheaper prices. If stocks take off, you’re participating in the rally.
Marie Kondo your personal finances. Kondo is the best-selling Japanese author and organizing consultant whose message touting the powerful effects of tidying up has implications for small investors, too. You can relieve anxiety about the markets and your portfolio by taking small actions in other areas of personal finance. Examples: Call your credit card company, and negotiate a lower interest rate on your unpaid balances. Open or add to an online savings account that offers higher yields than your neighborhood bank or credit union. Learn to deposit checks remotely with your smartphone. Consolidate your various retirement accounts at one brokerage firm. This won’t eliminate the market volatility, but it will help you feel more in control of what you have.
Make your investment actions accountable to a family member or friend. The intense shame associated with steep losses tends to isolate investors. Stuck in their own heads, they wind up making irrational investment moves to satisfy emotional needs. For example, a friend of mine had created a well-diversified portfolio, but recently he was so upset and embarrassed about letting down his family in the market meltdown that he wanted to move most of his retirement portfolio into the safety of US Treasury securities. I told him he had to be up front with his wife about such a big move. Talking to her relieved my friend’s psychological burden. It also gave him the emotional distance to realize that abandoning the market to feel safe would cost him gains that his portfolio had accumulated and compromise his larger goal of funding his retirement for several decades.
