We live in a numbers-obsessed culture, and nowhere is this more evident than in saving for retirement. It’s easy to get caught up in the numbers and become anxious about whether you’ll have enough money to carry you through your life. You may worry that your money won’t grow or wonder if market volatility will get the best of you.
These are all valid concerns, but they lead to the biggest financial mistake I see people making: focusing on rates of return. Why is this a mistake? Because we can’t control the markets, but they can control us.
Focusing on rates of return can become an obsession, which leads to taking on too much risk. We let panic get the best of us and end up making decisions that hurt us, not help us. While taking additional risk can work for a little while, sometimes even a long while, history shows that it won’t always be smooth sailing.
A 2015 DALBAR study, Quantitative Analysis of Investor Behavior, shows just how poorly investors performed relative to market benchmarks over time. The results tell us that the biggest reason for underperformance is investor decision-making. So while you might think the roller coaster of the markets is harming your portfolio, the truth is that your reaction to the markets is what puts your financial plan in jeopardy.
Acting On Emotion
When the going gets rough, are you willing to stick it out through the toughest parts of the market cycle, or will emotions drive you to “safety”? Many investors fall prey to emotional decision-making and, in an attempt to avoid losses or cash in on a potential victory, they buy high and sell low, which only serves to lock-in large losses. Strategies like “buy-and-hold” only work if you are willing to “hold” when things look bad. Many of us know that long-term investing is the path to success, but our emotions cloud our vision.
Here’s an example of why focusing on rates of return can be detrimental to your portfolio. The market goes up, you get excited, and you invest as much as you can. Then numbers drop, which they will always do, and you panic and sell. You’ve already lost money, but the problem goes further. The markets will go back up eventually, but investors who panic are not likely to return to the markets until they feel better, and that is when the market has recovered its losses. So they buy high again and repeat the vicious cycle. If they stayed put, even investing when the market was down, their losses would have been recovered eventually.
Since we are emotional creatures and nothing brings out our feelings like money, how can we break this pattern of emotional investing?
No matter how hard we try, we can’t live a risk-free life. But we can take steps to minimize risk and discipline ourselves to stick with our strategies. Here’s how we can control risk in two big-picture ways.
Maintain Proper Asset Allocation
Maintaining proper asset allocation is key. We’ve all heard about the importance of diversification when it comes to maximizing our investments. But as you get closer to retirement, it’s even more important to make sure you are investing in the right types of holdings. This is the time to reduce your risk and ensure that you have the right asset allocation. In this way, you can minimize the impact that any one losing investment can have on your overall portfolio performance.
Create Strategies And Tactics That Work
The markets fluctuate every day. You’ll only feel increasingly stressed and prone to making emotional decisions if you monitor your performance and adjust your investments every time something unexpected happens. It’s more important to maintain a long-term view and stick to a disciplined approach and avoid making decisions based on what the media is feeding you. This is your strategy.
Tactically, rebalancing is also a major factor in keeping your portfolio safe. It’s not enough to create proper diversification and just walk away. You need to regularly analyze your portfolio to ensure that it still reflects your appropriate level of risk and that you haven’t become too reliant on any one asset category. With the help of a financial professional, you can examine your portfolio for opportunities to adapt to the changing conditions, not based on emotion, but on history and data.
The Performance Measurement That Matters Most
When it comes to investing, what matters most is not market performance or this year’s hot stock picks; it’s applying the right behaviors to a personalized strategy based on your specific goals and needs. As you draw closer to retirement, you can’t afford to let your emotions dictate your financial behavior.
By using a disciplined approach, focusing on the long-term, and working with an independent advisor who understands investor behavior, you can avoid making the costly mistake of focusing on rates of return. To learn more about your investment portfolio and what does matter for your specific situation, call us today at 941-778-1900 or email email@example.com.