Coping with a down market

The current stock and bond market volatility can drive a sane person crazy.  If you find yourself checking your investments more frequently than you check your email, you may just be taking too much equity risk in your portfolio.

After almost seven years of impressive stock and bond market returns, the late summer’s sudden market dive has shaken many investors.  However, if you have a well prepared financial and investment plan, which anticipates bear as well as bull markets, you hopefully felt reassured that this decline was just part of the natural market process.  Thought we wish it weren’t so, down market periods are as inevitable as death and taxes.

How can we cope with a down market and not lose our equilibrium?

Many people have a tendency to stick with a losing strategy purely on the basis that they put so much time and money into their investment planning already. This can be a dangerous pitfall when it comes to investing. Now would be a great time to check in with yourself and see if you are properly allocated, based on your emotional behavior to volatility.

Are you the kind of person who won’t leave a bad movie in the middle?

Behavioral economists call this behavior the “sunk cost fallacy”.   For example, say you put a lot of time in studying a particular company; we will call it xyz market.  You shop at xyz, you’ve met the CEO at a wine tasting, your favorite products are at the local store and you bought a lot of their stock.  The stock does nothing for years, yet you hold on.  When it drops you buy more because you “just know” what a great company they are.  You are invested in every way, and both emotionally and financially.

The motivations behind the “sunk cost fallacy” are quite understandable.  We want our investments to do well and we don’t want to believe that all our efforts have been in vain.  No one likes to admit that they are wrong, it can be hard on our ego!

Here are a few fundamental ways in dealing with sunk cost fallacy when it comes to investments:

  1. Accept that not every financial decision you make will be a winner.  Markets fluctuate based on news, and the collective wisdom of all shareholders.
  2. Remember that risk and reward are related and that not every risk is worth taking.
  3. Diversification helps reduce risk, not eliminate it.  Overweighting one stock (xyz) or sector (precious metals) because you read something or felt something, will add tremendous risk to your portfolio.
  4. Educate yourself.  Understanding that by the time you’ve read that blog or heard news about a company or sector the news is already factored into the price of the stock.
  5. Don’t get emotional about your investments. (Yes, easier said than done!) Don’t sink emotional capital into a sinking stock that you just can’t let go of.  Try to keep emotional distance from your investments. If you can’t afford to lose it, consider a more financially conservative option for the money.
  6. Rebalance your portfolio regularly.  Being disciplined will keep your emotions in check and you will be able to let the markets work their magic.
  7. Turn off the news in volatile times.  Don’t torture yourself with information that will not help you make smart decisions.
  8. Consider working with a fee only financial planner if you aren’t already. An objective professional who is on your team and knows your goals and financial situation, can be an invaluable partner in helping you navigate the ups and downs of the market.