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Not Reacting with Emotion to the Market

Laura Culp

Oct 28 2019

3 min read

A disciplined investor should develop a long-term investment strategy to achieve his or her financial goals and adjust their strategy as goals change

Academic research has shown that no one can consistently time the market. Therefore, a disciplined investor should develop a long-term investment strategy to achieve his or her financial goals and adjust their strategy as goals change. The strategy should be based on the investor’s willingness, ability and need to take risk to achieve financial security.

Risk in Your Strategy

Risk and return are related; higher risk should result in higher returns over time. Investors need to understand the sources of risk and return for an investment and how the risks of each investment correlate with the risks of other investments in the portfolio. Therefore, a diversified portfolio is a key component of a sound financial plan to help manage overall risk.

How to Not Overreact to Market Volatility

Once your plan has been formalized, being disciplined and sticking to your investment strategy is easy, especially when markets are calm. This can however be quickly tested during extreme volatility. While it is natural to experience anxiety as market conditions change, reacting can lead to poor investment decisions. As the market rises, the natural tendency is to purchase investments that have risen too much. When markets decline, investors tend to sell investments that are doing poorly. This overreaction causes investors to end up with a losing strategy, buying high and selling low.

Instead of overreacting to market conditions, investors should adhere to their investment strategy, rebalancing the portfolio whenever allocations drift too far. Rebalancing results in selling assets which have recently outperformed when prices are high and expected future returns are lower. Assets that have underperformed will be purchased at lower prices, when future expected returns are higher. While this strategy is easy to understand, it is hard to practice unless we can keep our emotions in check.

Warren Buffet said, “The most important quality for an investor is temperament, not intellect.” Following this sage advice will allow investors to have the right temperament to ignore the volatility of the market and be disciplined, following your strategy through the inevitable market dips and swings.

Reference:

Loiacono, Stephanie. “Rules That Warren Buffett Lives By.” investopedia.com. https://www.investopedia.com/financial-edge/0210/rules-that-warren-buffett-lives-by.aspx

Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will increase in value, will be profitable, or will equal any corresponding indicated historical performance level(s).

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About the Author

Laura Culp

Laura Culp, CPA, PFS, MT, CCIFP, is a director with more than 30 years of experience working with the owners of privately held businesses to help them grow their wealth and implement tax saving strategies. Her extensive knowledge of the unique tax and financial issues that contractors and developers face is valued by her construction and real estate clients. Laura’s planning and wealth management skills provide clients with an integrated level of service, and clients appreciate her down to earth advice.