As an investor, there are a lot of things that can cause you to panic and make hasty decisions with your money.
Fortunately, if you have a good understanding of how you might react, you can minimize the potential damage to your financial future.
People simply aren’t rational when it comes to their money.
In fact, there’s an entire field of study dedicated to this known as Behavioral Finance. This field has uncovered many ways in which a perfectly intelligent person acts irrationally.
While this topic could easily be expanded into a textbook or two, we’ll briefly cover just a few of the more important topics and discuss what it means for your retirement.
People tend to be most comfortable investing in what they know. Most have heard the tragedies of Enron employees who put all their retirement savings in company stock only to see it evaporate when Enron went under.
While it’s highly unlikely that Procter & Gamble, Alphabet (Google), or other similar companies will go bankrupt, sustained moves lower in their stock price could hurt your retirement if you put too much of your hard-earned savings in a single stock or small group of stocks.
The best way to not fall victim to this is to make sure you have a diversified investment mix that matches your needs and risk tolerance.
It’s not uncommon for us to think we are better at something than we really are. In fact, about 73% of people believe they are better-than-average drivers (per an AAA study). To that end, some investors think their stock-picking ability will allow them to pick the next Apple or Microsoft.
In reality, stock picking (as well as trying to time the market’s ups and downs) explains less than 10% of your portfolio’s return variability. On the other hand, asset allocation explains more than 90% of the return variability.
The takeaway here is to make sure your focus is on having the right asset allocation and not on picking the best stocks or trying to time the market.
As its name implies, herding occurs when we follow what others are doing instead of thinking for ourselves. This can often occur when there’s a lot of bad news in the media. Unfortunately, that happens all too often, as fear is what sells.
This fear can become a problem if the things other people are saying convince you to sell out of your investments. After you’ve sold, you’re left wondering when to get back in. People might make that decision to sell because they hate experiencing a loss. After all, the pain of a financial loss is twice as great as the enjoyment of a similar gain.
Unfortunately, this could mean you miss out on large rallies after you’ve sold, which is quite possible since stocks tend to head higher over time.
Working with a reliable advisor, someone who has a deep understanding of the economy and markets, and who will approach your investments unemotionally, will help you overcome the herding effect.
Your Risk Tolerance in Retirement
People’s feelings about certain things often change during retirement. It’s normal for fear to increase. It’s also perfectly normal to feel more anxious once you retire. Understanding how the market behaves can help you manage these feelings when turbulence increases.
Getting caught up in the day-to-day noise can be very easy. After all, every headline about the U.S. – China trade war makes it seem as if we’re on the verge of economic Armageddon. These headlines often drive what happens in the short run, and sometimes they result in scary moves lower in the broad stock market.
However, this is daily noise, but markets have moved higher over the long run. Over the past 50 years, large-cap stocks were higher just 53% on any given single day. That’s basically a coin flip!
Fortunately, the odds are in your favor if you’re a long-term investor. We crunched the numbers from Bloomberg data, and the same group of large-cap stocks were higher a staggering 96% of the time when looking at every 10-year period over the past 50 years!
Your #1 Enemy
Your emotions are your worst enemy when it comes to enjoying your retirement. A diversified portfolio based on your personalized financial plan will help minimize the risk of making a costly emotional decision, and this will help you enjoy a better retirement.
All data from Bloomberg. Past performance does not guarantee future results. Any stock market transaction can result in either profit or loss. Additionally, the commentary should also be viewed in the context of the broad market and general economic conditions prevailing during the periods covered by the provided information. Market and economic conditions could change in the future, producing materially different returns. Investment strategies may be subject to various types of risk of loss including, but not limited to, market risk, credit risk, interest rate risk, inflation risk, currency risk and political risk.
This commentary has been prepared solely for informational purposes, and is not an offer to buy or sell, or a solicitation of an offer to buy or sell, any security or instrument or to participate in any particular trading strategy or an offer of investment advisory services. Investment advisory and management services are offered only pursuant to a written Investment Advisory Agreement, which investors are urged to read and consider carefully in determining whether such agreement is suitable for their individual needs and circumstances.
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