Volatility is back, posing perhaps the biggest challenge stock investors have faced in this six-year bull run: How do you stay sane in a crazy market? In March alone, the Dow Jones industrial average seesawed wildly, closing up or (more often) down more than 100 points on 16 of 22 trading days. The jumpiness is all the more jarring because of the remarkably smooth uptrend we enjoyed previously. Standard & Poor’s 500-stock index has gone 41 months without a decline of 10% or more (the classic threshold for a market correction). Since World War II, corrections have come every 18 months, on average, according to S&P Capital IQ.
So what’s the harm in a little volatility now? Nothing, inherently. As Jay Mooreland, a financial planner who writes The Emotional Investor blog, puts it: “Volatility doesn’t cause losses. It’s investors’ reaction to volatility that causes losses.” And those reactions are deeply rooted in the biases and behavioral traps that are part of human nature. William Martin, a financial psychologist at Aequus Wealth Management Resources, in Chicago, highlights some biases that often surface during times of market volatility:
When we’re uncomfortable, we seek support, often from information that affirms our point of view. If you’re convinced the market is going to you-know-where in the proverbial handbasket, you’ll seek out like-minded opinions, turning a blind eye to other scenarios.
If we’re unsure of ourselves, we’ll follow the crowd. That’s unfortunately why investors buy high and sell low—loading up on shares when everyone else is buying and dumping holdings when most people are selling.
Fear of Regret
No one wants to feel bad because of a poor choice, whether it’s buying the wrong investment, holding it too long or selling it too early. This regret avoidance can be exacerbated, says Martin, by the endowment effect, which can cause us to put a higher value on investments than they’re worth.
Booking a loss is never easy, but holding on to hope that you’ll eventually get even can cause some investors to ride losing propositions down to zero.
How to Cope
Buffeted by such biases, investors tend to fall into two camps during periods of market volatility, says Michael Liersch, director of the behavioral finance unit at Merrill Lynch Wealth Management. “Some put their heads in the sand and ignore everything. Others overreact.” Liersch recommends that investors try to strike a balance between the two.
One way to do so is to stop focusing on a benchmark. (Turn off the TV, and don’t obsess over your account statements!) Instead, be mindful of what the money you’re investing is meant for and how it’s invested to meet those personally meaningful goals. Are you investing for retirement income? Educational funds? A down payment on a house? Different goals dictate different strategies. Crafting an investment policy statement—and an exit strategy—before the going gets rough helps take the emotion out of buying, selling and rebalancing decisions.
Similarly, casting a wide net when seeking information and investment advice can help make sure you’re not unduly influenced, including by your own opinion. While you’re at it, make an effort to seek out someone who you know will present the contrarian point of view. That, along with the rest of these strategies, can keep you from diving off the cliff with the herd.
Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.
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