Taking the Emotion out of Investing

The election of Donald Trump to the highest office in the land came as a surprise to many prognosticators in the media. What can we learn from this huge political upset? It turns out that people are prone to making mistakes. In this case, the mistake was presuming that Hillary Clinton would win. This foregone conclusion was not drawn in a vacuum; pundits relied on polling data, early voting data and political intel for their predictions. And while these methods have worked in the past, as many a financial prospectus warns, past performance is no guarantee of future results.

Market Jitters

When it became clear that Trump would secure the 270 electoral votes needed to win, financial markets swooned. The Dow shed nearly 650 points in after-hours trading, while futures for the S&P 500 dropped 4%. And the carnage wasn’t limited to U.S. markets; Japan’s Nikkei lost 5% in early trading, while the Mexican peso plummeted almost 12%.

This drop was followed by a hasty snapback that saw the Dow gain 3.79% between election day and the market’s close on November 16. Appearing on CNBC that day, First Standard Financial’s chief market economist, Peter Cardillo, pointed to the outsize gains in financial and industrial sectors. In the eight days following the election, Goldman Sachs and JPMorgan Chase led the way, soaring more than 17% and 14% respectively.

With those impressive gains, investors are attempting to digest how a Trump presidency will impact their portfolios moving forward. If you were lucky (or prescient) enough to be positioned for a “Trump trade” ahead of the election, you’ve done well. But benefiting from such largely unforeseen developments is not unlike hitting a hot streak in Vegas. There is a certain amount of euphoria involved. And whether it’s greed or the fear of missing out, investors can get carried away. Knowing when to walk away is essential to long-term success, and this requires discipline and a concrete plan—which, sadly, many investors lack. (For related reading, see: Why the Market May Not Trust Trump Long Term.)

The S&P 500 Model

The S&P 500 is an excellent example of how sticking to a plan can minimize risk and maximize gain. The rules of this index are simple: track the 500 largest companies. That’s it. No fear, no greed, no panic. It’s a mechanical model with the human element removed. And it’s why, despite their exorbitant fees and stellar reputations, the vast majority of fund managers fail to best this benchmark.

Following an investing philosophy based on a reliable set of rules is, in the long run, a much better approach to building wealth than investing on a whim in this stock or that fund. The principal advantage of a plan—any plan—is that it leaves no room for impulsiveness. Fear and greed have no sway over a rational set of rules. Following a strategy based on sound fundamentals rather than jumping from strategy to strategy, gut feeling to gut feeling, doesn’t guarantee you’ll win every sprint. But you’ll greatly increase your chances of winning the marathon that is long-term investing. (For related reading, see: 4 Benefits of Holding Stocks for the Long Term.)

Stop-Loss

It’s helpful to place today’s bull market in context. As long as the market is chugging along, reaching fresh new highs, investors are happy. But when things change—which they inevitably do—those gains can be easily wiped out. Consider this: The average investor’s portfolio barely keeps up with inflation. From 1992-2012, individual investors earned just 3.83% compared with a 9.14% return on the S&P 500 and a 6.89% for the Barclays Aggregate Bond Index. Emotions cause investors to act counter-productively—staying in for too long at the top and waiting on the sidelines for too long to get back in. 

When this aging bull market finally morphs into a bear, many investors will be caught off-guard. But you can protect yourself with a stop-loss strategy designed to mechanically minimize losses. With predetermined triggers in place to lock in gains and prevent major losses, you need not worry about what to do with your portfolio. Your strategy—and not your emotions—will dictate your actions. (For related reading, see: The Stop-Loss Order—Make Sure You Use It.)

And the Winner Is…

A rational approach to investing would have guided you through election night unscathed. A dip of that magnitude invariably raises the question of whether we have finally reached the end of one of the longest-running bull markets in U.S. history. Surviving market volatility is possible, but it requires a plan that can stand apart from the gloom and mania. The health of your investment portfolio depends on your ability to take the emotion out of investing.