With the stock market at all-time highs, investors are in the classic situation of having an angel on one shoulder and a devil on the other. The problem is that most investors can’t tell who is who, which emotion is wearing the wings versus the horns.
On one shoulder, there is greed. The market is at a high and, depending on who you talk to, poised to go higher. Doubters who never believed that the market’s rally was strong now have no choice but to acknowledge that it has recovered all ground previously lost, and then some. For someone who has been out of the market – or at least holding back – there’s the desire not to miss out, an emotion that is encouraging full-speed ahead.
On the other shoulder, there is fear, the idea that once the market peaks, it is likely to go down. That’s particularly true right now, when the market has climbed a wall of worry and scary headlines, with plenty of experts saying that the market was overdue for a blow-off. Both of these messengers are whispering to you, one side calling this a bull market, the other a bear trap.
Here’s the secret: The fact that the Dow Jones industrial average reached new highs matters to the market, but unless your financial goals were to hang in until the market reached a new peak – at which point you could cash out, never invest again and live happily ever after – it’s not that big a deal to any individual. (Before you start screaming, it would be the same if the index hit a 10-year low.)
For today’s investors to reach their financial goals, the market is going to have to go a lot higher than it is today; if all it does is grow at 4 percent a year, on average, it will be twice this high before two decades have passed. All that matters is what happens next, and what you intend to do about it. As noted by Terrance Odean, a professor at the University of California-Berkeley: “Much of (investors’) focus and regret is on what has happened and what they wish they’d done differently.”
Experts in behavioral finance say the best way to calm the two voices in your ear is to step away from the market, at least for long enough to size up your situation and to get hold of your emotions.
“You should step away from your emotions and assess them from some distance, just as you count to 10 when you’re angry, before you speak,” said Meir Statman, professor at Santa Clara University. “Stepping away, you’ll note that it is common to be hopeful – a preferred term over ‘greedy’ – after stock market ups and fearful after stock market downs. You’ll note that the fear induced by the crash of 2008-09 was massive, lasting long after the stock market recovered almost all its 2008-09 losses. You’ll note that what you really fear is the regret you’ll feel if you buy now and find later that you’ve bought at the top.
“Don’t jump into stocks with all your money,” he added. “Regret will kill you if the market goes down. Don’t stay on the sidelines with all your money in a money-market fund; regret will kill you if the market goes up. Instead, step into the market gingerly with dollar-cost-averaging, the great regret mitigator.”
Charles Rotblut, editor of AAII Journal, published by the American Association of Individual Investors, noted that the way to ignore the voices is to set your own tone in an investing plan.
“One of the biggest mistakes investors make is focusing on the short-term movement of the market without having a mechanism in place to prevent their emotions from influencing investment decisions,” Rotblut said. “Write down how many years it will before you need the money and then, based on this information, write down an appropriate allocation. Whenever you get nervous, look at the allocation and ask yourself, ‘Is my portfolio allocation still close this ideal or do I need to alter it?’”
Dr. Richard Geist, head of the Congress on the Psychology of Investing, had a plan as part of his means for beating the voices too. “There are three ways to avoid letting (either) side win out,” Geist said. “One, invest alongside a like-minded other who can help keep your irrational side in check. Two, have a personal plan for your investments, such as some speculative investments that you may sell if the market reaches an all-time high – but keep your long-term investments knowing the market goes up two-thirds of the time. Three, try to forget about fear and greed and focus instead on understanding your companies or mutual fund managers.”
Focus more in your investments and what they will do no matter which way the Dow goes next or how big the move looks. Prep for what could happen and how you would react, rather than trying to guess at what’s next and hoping to get lucky.Chuck Jaffe is senior columnist for MarketWatch. He can be reached at email@example.com or at P.O. Box 70, Cohasset, MA 02025-0070.