Have you been wincing over the stock market’s decline since the beginning of the year?
Have you considered selling some stocks to avoid a potential bloodbath?
What factors are you considering in your decision? Emotion, or logic?
How would you feel if you knew we were at the start of a 15 year bull market?
Emotion, or Logic?
As I write this, the Dow Jones Industrial Average is down 8% in the past month. OUCH. As someone within a few years of retirement, I can relate to folks who are nervous. We NEED that money to cover our retirement living expenses, right?! Maybe we’d be best to avoid the potential losses and just park our money in “safe” investments, at least we’d know what we have to work with. I can hear the arguments inside your head. I’m having the same arguments between The Id and The Ego.
Over the past month, I’ve been thinking a lot about market volatility. I’m getting closer to retirement, and this is the first real volatility that I’ve experienced within the “red zone”, the critical 5 years before and after retirement. In the past, I’ve been surprisingly unconcerned, almost happy, about market downturns. As I explained in “5 Moves I’ve Made In Today’s Market Volatility”, downturns are a great thing for any “younger” investor. As you age, however, they become considerably more concerning. I know; I’m experiencing it. Hence, my second article on the topic in 3 weeks. This one will focus on human tendencies, and how they can lead us to make bad investment decisions.
This is important stuff, and we can’t let fear lead us to making poor decisions.
Markets have always been volatile, and the “average” investor has a terrible track record of selling at the wrong time, resulting in lower average returns than the market as a whole. This article from USA Today points out that over the past three decades, the S&P500 has returned 9% on average, but the average investor return was only 1.9%. There is a LOT written on this phenomenon. I did a quick Google search on “The Average Investor Underperforms” and had 57,000 results. After reading 52,000 of the hits (NOT), I came across the following quote from Why The Average Investors Return Is So Low (published in Forbes):
“Investors may only have themselves to blame….investors make poor investment choices that hurt their investment returns. These decisions, including when to buy and sell, are often driven by emotion.”
The study of investor behavior is called “Behavior Finance Theory” (26,000 hits on Google), and is a fascinating topic worthy of many future posts (note to self). For today’s article, let’s just accept that emotions often lead us to making bad decisions, which result in sub-optimal investment returns. If we can learn to avoid these natural urges, our long term returns should improve.
Better returns. Better Retirement.
Pretty simple, but we almost always get it wrong. Most of us are unaware of this natural tendency to let our emotions drive us to poor investment decisions. The point of this article is to highlight that natural tendency, and hopefully force you to overcome your natural emotional tendency when making investment decisions in times of market volatility.
The quote below, from Behavioral Risk In The Retirement Red Zone, by Prudential (one of the 52,000 articles I read….) does a good job of summarizing the issue:
Bottom Line: recognize your natural tendency is likely wrong, and THINK before you ACT. Especially in volatile times.
Are We In A 15 Year Bull Market?
The title of this post was intentional. As this article on Investopedia explains, Behavioral Finance Theory argues that our natural priority is to avoid losses. With all of the market headlines screaming about a potential bear market, our natural tendency is to sell and avoid the loss. The reality? The market’s already lost 8%, and it’s likely not in your best interest to sell.
So, I chose a headline that screams about potentially huge gains ahead. Yes, I’m playing with your emotions. Sorry about that. However, you are reading this, so it must have worked. There may be something to this Behavioral Finance Theory.
I came across this bullish headline this morning, on a Kiplinger article entitled Bear Market? I See a Bull Market for the Next 15-20 Years. In it, the author posts the following slide:
The author goes on to argue that we’re at the start of a 15-20 year bull market. I won’t get into his arguments, but it’s an interesting article. He may be right. He may be wrong. The only thing I’ll guarantee is that he’s one of the two (he’s either going to be right, or he’s going to be wrong). The point is this:
We Simply Don’t Know
Investing would be easy if we knew which way the markets were going. We don’t, and we never will. Instead, we must have a long term plan and stick with it. According to all of the experts, unless you have such a massive amount of wealth that you can afford to avoid all risk, the reality is most of us need to be invested in stocks to insure sufficient growth.
Too little growth = money runs out before you die.
I don’t know about you, but I’m not too excited about that prospect.
Things You Can Do
First, you must understand your tolerance for risk. If you’re nervous, have a smaller exposure to stocks and a larger cash reserve. Follow these steps to increase the odds that your money will last through retirement. Read this if you want to know what I’m doing in today’s market. I’m not an investment advisor, and I’m not telling you what to do. My approach may be wrong. My approach may be right. (I can assure you it’s one of the two.)
However, I have a plan, and I’m sticking with it. If you’d like to see how Darrow Kirkpatrick, an ultra-cautious early retiree expert is approaching things, read this. Plot buster: he’s keeping 10 years in cash to insure he’ll survive even the longest bear market. Like me, he has a plan.
You may find it reassuring, as I do, to keep this quote from Warren Buffett in your mind as you ponder your investment strategy. To me, it’s a simple way to remind ourselves to not let emotions overrule logic when making investment decisions:
The point of this article is to highlight how our natural tendencies tend to lead to investment mistakes. Don’t over-react to short term market volatility. Have a long term plan. Don’t invest too much in “safe” investments and fail to keep up with inflation. Retirement is too critical an issue to make mistakes with your investments. You’re reading this, so you’re ahead of 90% of the population. You’re learning, and you’re engaged. Congratulations. If you’re uncomfortable managing your money, head over to Paladin and find a great financial advisor. Whatever you do, don’t leave your retirement to chance. More importantly:
Don’t leave it to emotion.