Keep Emotions in Check When Making Decisions

The continuing sluggish economy has pushed some investors’ emotions to the extreme. Deciding what to do with your investments during tough times can be difficult, and emotions sometimes get in the way of making sound choices. But there are ways to maintain your objectivity.

Effects of Emotion

One reason emotions can come into play is that people tend to extrapolate future performance from recent trends. When the markets are moving steadily downward, for example, fear can kick in. In an effort to minimize their losses, investors may unnecessarily lock them in by selling otherwise good investments at bottom-of-the-market prices and then holding funds in cash while the market rebounds.

In difficult economic times, investors also may overlook potentially good buying opportunities, instead seeking “conservative” investments, such as money market investments. Because of their limited appreciation potential, however, these are a poor choice for many long-term investors who need to keep their assets growing faster than inflation.

Other investors, however, fall victim to the fact that people often don’t like to admit when they’re wrong. That stubbornness can cause them to hold onto a bad investment (one with little potential to rebound) rather than cut their losses and reinvest the remaining proceeds into a better opportunity.

And yet another potential pitfall for investors is the financial news media. Too much information focused on short-term market conditions — made possible by the Internet and 24-hour financial news networks — can also lead to poor financial choices. When investors don’t know how to prioritize the flood of “noise” that they read or hear, they may become paralyzed with indecision or resort to unprofitable strategies, such as excessive trading.

Controlling Emotions

Even though it’s natural to experience emotions in response to market volatility, there are steps you can take to reduce their impact on your investment decisions. For example, consider taking advantage of an automatic investment plan. Offered by most financial institutions, these plans allow you to invest set amounts of money at regular intervals. By investing on a schedule, you can avoid the temptation to buy and sell at inopportune times, and actually buy larger quantities when prices are lower.

It’s also important to develop, and stay focused on, an individualized wealth management plan. As a financial advisor, my goal is to help investors determine the appropriate asset allocation for their age, goals and tolerance for risk. Once a plan is created, we encourage investors to stick to it regardless of what’s happening in the market. Over time, we’ll review your financial situation and discuss any changes to your plan that may be needed.

Finally, we can’t stress enough the importance of a broadly diversified portfolio. As the truism goes, avoid putting too many of your eggs in one basket — whether it’s your employer’s stock, a “can’t miss” opportunity your friend is touting, or just a successful investment that you’ve held for many years. Owning various types of securities that will respond differently to changing market conditions is one of your best defenses against market volatility. Knowing that your portfolio is broadly diversified and well positioned for the long-term can help reduce your temptation to make spontaneous investment decisions.

For those interested in reviewing their investment plans, year-end is a great time to revisit your long-term goals to ensure that your portfolio remains properly positioned based upon your needs and objectives. Please feel free to contact us for a personal portfolio review, or if there is any way that we can be of assistance.