If someone took half of your money and tossed it off the side of a cliff, would you be relaxed about it?
Our guess is probably not.
But that’s exactly the way it can feel when the stock market is going off the cliff. Your Twitter feed is blowing up with panicked headlines, MSNBC is showing a painful play-by-play of the financial carnage, and when you check your 401(k) or brokerage account, the money you’ve “lost” makes your heart race.
Of course, on the flip side, it’s just as easy to get caught up in the euphoria of a record-breaking stock market. Both situations—a steep drop or a big bounce—can roil your emotions, making you think that you need to do something. Anything.
But emotional investing is never a good idea—those who give into their fears (or greed) tend to buy high and sell low, which is the opposite of a good investing strategy. So we talked to LearnVest Certified Financial Planner™ Brandie Farnam to find out how she keeps her own clients calm when stock market chatter gets to be too much.
Keep Your Investing Cool Tip #1: Don’t Be Impetuous
“None of us have a crystal ball to tell us exactly where the market is headed,” Farnam says. And that includes professional investors, who have access to sophisticated data and analysis. So if, as an average investor, you’re trying to make a quick buck by timing your purchases and investment sales to sudden stock market ups and downs, the reality is that you’ll probably end up losing.
In fact, studies show that investors who try to consistently time investing decisions to the market tend to buy high, sell low and underperform the market. In other words, they make less money than investors who buy and hold.
Your Take Away: Don’t make investing decisions based on what you think the market will do.
Keep Your Investing Cool Tip #2: Think Long-Term
“We don’t recommend investing with less than a five-year time horizon,” Farnam says, pointing to the last five years as a poignant example.
Let’s say that, five years ago at the end of March 2008, you invested $20,000 in the U.S. stock market, with a plan to pull out those funds a year later to use as a down payment on a house. But when the time finally came to sell your investments 12 months later to close on your dream home, the market was down about 40%. You would have locked in a staggering loss of over $8,000. Ouch.
But if you were operating under a longer-term time horizon plan of five years, you’d be selling that investment today for a net gain of more than $3,800—despite all of the market turmoil that’s occurred over the past five years.
Your Take Away: If you have a longer-term horizon plan in place, when you jump into the market matters less because it has historically gone up over the long term.
Keep Your Investing Cool Tip #3: Rate Your Risk
If you have confidence in your portfolio, you’ll be better able to resist wanting to make brash investing decisions when things get scary in the market. The key to achieving that level of confidence? Figuring out your risk profile, which is basically a fancy term for the level of risk that you’re willing to take on.
If you’re young, and you plan to stay invested for 20-plus years, you can afford to have a portfolio comprised of more volatile investments, like tech industry stocks. But if you’re close to retirement or you need to pull out your money within 10 years, you should likely have ”safer” investments, such as bonds and blue-chip stocks, which tend to remain more stable in value.
Your Take Away: When the market goes haywire, knowing that you have an asset allocation that’s right for you can mean the difference between feeling total panic and a more Zen financial attitude. Hint: LearnVest CFPs®, like Farnam, can advise you on the best portfolio mix for your situation.
Keep Your Investing Cool Tip #4: Be Average
Even if you have a long-term approach, and you’ve figured out an appropriate asset allocation given your risk profile, you may still feel apprehensive about throwing a lot of money into the market all at once. And that’s understandable.
The solution is dollar cost averaging, in which you break your money into equal chunks and invest at set intervals. For example, you can decide to invest $500 on the first of every month, which would reduce emotional investing because you’d purchase shares independent of what’s going on in the markets. This also has the advantage of making sure that you buy fewer shares when the price is high, and more shares when the price is low, ultimately giving you more value for your money.
In fact, you may already be using this strategy if you’re allocating a set percentage of your salary toward your 401(k) every pay period. You can also do the same thing for a regular investment account by setting up regular purchases through your online brokerage.
Your Take Away: Take the stress out of purchasing investments by doing it automatically.