One of the biggest ways we as investors can get in the way of meeting our goals is by letting our emotions dictate our investment decisions. Some investors act too late and invest at the top of the market. These “Overly Optimistic Oscars” convince themselves to make a big investment when they see the market on an upswing, fearing they’ll miss out on a big return. But when the going gets tough and the market tumbles, they quickly sell their investments at a loss. Other investors, the “Nervous Nellies,” are afraid to make an investment at all and they lose out on the upside the market can provide.

 

The Behavior Gap

Many of us know that trying to time the market is about as accurate as guessing which way the wind is going to blow a year from now. We just can’t know. Guessing can result in big investment mistakes. Think back to a volatile financial period in your own life. Maybe 2008 is still as fresh in your mind as it is for many others. Did you have a plan for your investments in a down market? Or did you panic and sell everything only to wait and wait before investing again?

Emotional decision-making in volatile markets leads to what’s known as the “behavior gap.” The gap between the market’s return and the investor’s personal return key to investment success is to find an investment approach you can stick with for the long term and eliminate the behavior gap altogether.

The Solution

So, how can we avoid letting our emotions control our investment choices? We work with clients to identify the appropriate investment allocation based on their goals and time horizon. From there, we aim to maintain your target mix of stocks, bonds and specialized investments. We do this by periodically rebalancing your portfolio back to your target. Rebalancing involves selling asset classes that are overweight and buying asset classes that are underweight. This often means doing exactly what emotions tell us not to do – selling your best-performing asset class. We’ll invest that money in another asset class to move back to your target allocation.

The old adage to buy low and sell high is exactly what will happen if you rebalance correctly. It may seem scary, but this methodical approach will keep you on track for the long term.

The previous post in the series can be found here.