With stocks in a steep decline last week and worries of more pain to come, investors tend to make decisions based on emotion, often resulting in selling low and buying high. While keeping emotions in check is easier said than done, it can be a big benefit to your investment plan.
With that in mind, Vanguard offered up strategies to make sure that investors don't react emotionally when stocks are declining, and it all starts with recognizing that the impulse to act in the face of volatility is real. It's understandable to feel the urge to flee for lower-risk investments when portfolio balances are declining, but it will be to your detriment. This reactive sentiment could result in you missing out on the worst trading days, but it could also mean you'll miss out on the biggest gaining days as well. If you are able to recognize the urge and understand the negative implication from acting on it, you may do nothing, which is often a better strategy.
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Another defensive move against acting on emotion is to create a well thought out investment plan that takes into account your objectives, time frame, risk tolerance and the proper asset mix. You also want to determine how much and often you will contribute to your portfolio and when and why you will rebalance it. Having that plan in place will prevent you from acting when markets decline or surge.
"In essence, a financial plan is a pinnacle of proactivity. It's a blueprint that's designed to give you the best chance for investing success," said Don Bennyhoff of Vanguard Investment Strategy Group in the recent blog post. "Putting time and effort into your plan initially can benefit you in the long term – and each time you're faced with what's making headlines." He noted that the financial plan acts as the anchor that will help you reach your long-term goals, not necessarily to outperform along the way. Sure, the headlines are scary, but if you ignore them and have a well established financial plan, the daily gyrations shouldn't affect you or your emotional state.
Seeing the forest for the trees can also go a long way in tempering any urge to sell in a down market. That means focusing on the performance of your portfolio over long periods of time, not every time the stock market moves up and down. It may be hard not to look at your investment account with weeks like investors have been seeing in February, but refraining from obsessing over your portfolio will prevent you from reacting and give you some peace of mind.
Nobody is advocating burying your head in the sand, but not focusing on your investments every day or hour can prevent you from acting on emotion. "If you're on the brink of making a change to your portfolio, ask yourself what's driving the change," Bennyhoff said. "Is it driven by the market and what's in the headlines, or by a change in your circumstances? We generally don't recommend changing your asset mix unless your circumstances have changed."