| |
Does investing put you on an emotional
roller coaster? If so, you are not alone. The fluctuations of the
market are hard for most investors to stomach, and many suffer from
financial ‘motion sickness’ as a result. But making investment
decisions under these circumstances is a recipe for disaster. Read
on to find out how you can get off the emotional roller coaster of
investing.
If you feel that you are on the investment roller coaster—if you lie
awake at night worrying about your investments or get a knot in your
stomach when you hear the markets have fallen—then you most likely
have not allocated your portfolio so that it matches your emotional
risk tolerance. Changing the allocation of your portfolio should
alleviate this problem.
Investors find themselves on an investment roller coaster when their
‘intellectual’ risk tolerance doesn’t match their ‘emotional’ risk
tolerance. This creates a ‘fear/greed’ cycle that causes many
investors to constantly adjust their portfolio based on short-term
circumstances instead of a long-term strategy.
For instance, an investor intellectually agrees with the benefits of
equity investing and he decides to put a significant percentage of
his money into stock market-based investments. But when the market
starts going down, fear grips him and he can’t take it. He wants
out.
Once the market recovers, his fear turns to greed. The market went
up, so why didn’t his account? He blames his advisor for not telling
him to buy, when in fact the investor didn’t act because of fear.
Don’t get me wrong. There is nothing wrong with tactically reducing
the amount you have invested in equities to protect your money.
That’s exactly what my proprietary money management system is
designed to do. But in this case, I am talking about rapidly
changing the long-term strategy based on normal market fluctuations.
The problem isn’t necessarily that the investor panics and sells,
but that fear then keeps them from getting back into the market when
they should. Instead of buying when everyone else is afraid, they
wait until the market recovers and it’s too late. They sell low and
buy high.
Let me give you a real-life example. After meeting together
countless times, one of my clients agreed that having approximately
40% of his portfolio allocated to high-quality equities was the best
way to help him achieve his goals. We talked extensively about the
implications, did extensive research on each investment used, and
invested the money.
Within a couple of months, this client was beside himself because he
had lost $20,000!
But let’s put this loss in perspective. Although the market was down
several percentage points, his account was down less than 1%. If you
can’t tolerate a fluctuation of 1% then you shouldn’t be in
equities.
We reduced his equity percentage down to 7% so he could sleep at
night. By the end of that year, the market was up 8%. Most of that
gain (as it usually does), came very quickly in a short period of
time. And it started (as it usually does) right when nobody thought
it could go up.
This client allowed the fear over a 1% loss to prevent him from
achieving an 8% gain.
You will only know your true emotional risk tolerance after it has
been tested. When tested, we learned that this client’s emotional
risk tolerance was much lower then expected. Only then were we able
to achieve the appropriate portfolio allocation.
That’s why it is so important that you have the ability to easily
make changes to your portfolio without significant cost. That’s why
I so adamantly oppose investments that have surrender charges—they
cause you to lose your flexibility.
Also, your comfort with investment risk will change over time based
on your experience and your situation. This client is becoming more
comfortable with normal market fluctuations. We are increasing the
percentage he has allocated to equities, but we are doing it slowly.
Recognize that your emotional risk tolerance is probably much less
then your intellectual risk tolerance. Start slowly. Build up over
time. Be flexible. And work with an advisor who understands and is
able to help guide you along the way.
Have a financial question? Send me an email and I’ll personally
respond, free of charge. Go to http://www.guardingyourwealth.com and
click on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
|
