Stick to Your Investment Plan
Any solid investment plan will only work if it is adhered to during varying market environments. In the face of market turmoil, some investors may find themselves tested, making impulsive decisions that go against their investment plan. Although markets have rewarded discipline, humans are unfortunately not wired for disciplined investing. Does any of this sound familiar:
“I wasn’t wrong about that stock–just unlucky”
“It was a bad idea, but I don’t want to sell at a loss”
“I knew this stock was going up”
“My research confirms that this is a great stock”
When people follow their natural instinct, they tend to apply faulty reasoning to investing (read more about rational investing). They may struggle to separate their emotions from their investment decisions. Investors who follow a reactive cycle of excessive optimism and fear may make poor decisions at the worst times. It’s actually very tough, if not impossible, to know which stocks, market sectors, or asset classes will do better than others. Indeed behavioral economics suggests that overconfidence in your ability to pick winners is a typical bias, reinforced in hindsight by our tendency to seek out confirming, rather than objective evidence. For all practical purposes, markets are efficient, which means that all available news, information, and expectations have already been priced in. The only information that’s not priced in is tomorrow’s news, which is impossible to predict. Speculation simply does not make sense for most, if not all investors.
Instead, discipline has been shown to help explain differences among investors’ returns capture. Accordingly, it’s better to avoid market timing calls and other unnecessary changes that can be costly. Allowing emotions or opinions about short-term market conditions to impact long-term investment decisions can lead to disappointing results. To build wealth, an investor should stay in his or her seat and forget about the daily financial weather that’s defined by market news and headlines about the economy, companies, and politics. Instead concentrate on the long term financial climate, the growth of wealth over time (read more about Climate vs. Weather).
Of course, maintaining discipline relies on first developing a solid investment plan that considers the investor’s tolerance, capacity, and need for risk, then matching the investor’s risk profile to a risk appropriate portfolio of low-cost, globally-diversified index or asset mutual funds. If an investor is comfortable with their portfolio’s exposure to risk, then he or she will be more likely to stick with it for the long term. Missing only a few days of strong returns can drastically impact overall performance.