Managing fear and greed is key to successful investment, even during bull markets

Entering February, 15 of the past 16 month-end values for the S&P 500 Index of U.S. stocks have set new all-time high marks. Considering the entire decade of the 2000s had only nine month-ends that posted all-time highs, the pendulum of market returns has swung exceptionally to the positive.

Persistently positive returns and low volatility in the broad U.S. stock market (there is still a wide range of outcomes for individual stocks within the market) have drawn growing cash flow into stocks even though they are by some measures historically expensive.

In times like these, three common responses prevail — fear, greed and disciplined awareness.

In just the past week, I’ve had discussions with clients who fit each characteristic. Some people assume all good things will end badly. They fear a downturn and want to try to navigate around it. Others get greedy with hopes that the momentum will continue and they can capture more market lift. The most successful investors, however, manage the tugs of fear and greed and stick to a sensible long-term strategy. They return to tenets of prudent investment management as an anchor for their financial decisions, trying to keep emotion and biases from steering them off course.

There is too much nuance in the continually adapting marketplace to state with certainty the direction of any investment in the short term. But successful investing is not defined by evaluating when to be in or out of any individual stock or fund. For serious, long-term investors, it’s time in the market that is more important than timing the market.

You won’t be able to time your way around volatility, and you should expect more choppiness in market prices than we’ve experienced recently. The S&P 500 didn’t have a dip of more than 3 percent in 2017. On average, even in the strongest years, declines of more than 10 percent interrupt the longer-term rise. There hasn’t been even a 5-percent decline in S&P 500 in over 18 months, approaching the longest streak ever. When a correction occurs, it will get people’s attention, but declining values should not be your primary gauge of investment risk.

The definition of risk that should most influence your decisions is whether the probability of achieving your financial goals or obligations is significantly changed. If you don’t know enough about the relationship between your assets and your goals to evaluate the probability that one can fund the other, you need to start there before making decisions about what type of investor you are or should be.

Whether you are a conservative investor or aggressive, the best portfolio for you is the one you can be disciplined enough to consistently apply over time. A good strategy you can stick to will outperform a great strategy that you aren’t disciplined enough to implement when fear or greed cause you to be reactionary in the short-term.

Guarding against overreaction when times are good and when times are bad – combating human nature and deeply ingrained psychology – is more important than whether your portfolio fully keeps up with the gains of a bull market.

Our reactions are often driven by outside forces. News or forecasts of the economy or investment markets (two very different things, by the way) should have less influence on your investment decisions than news of personal life changes. Most likely, you are advancing a decades-long or even multi-generational financial plan. There isn’t likely to be any signal in today’s news for how you should be invested over a long period.

This doesn’t mean you should sit idly and be detached from your money. To invest successfully, you should know your financial goals and manage your investments to help you achieve these goals. Even if not actively making choices whether to be here or there in the global marketplace, most investors will have ongoing decisions to make about contributing new savings to or withdrawing money from accounts. These decisions should be easier to make if you have an investment process aligned with your goals and important planning assumptions more so than with momentary attractiveness of any particular market segment.

As stock markets become more expensive, prospective future returns are lower. There is little indication that becoming more aggressive to ride this long wave of momentum is the answer, and it might not even be necessary if you understand the relationship between your assets and your goals. Gains of the past several years might have you well positioned to cover your needs, wants and wishes without reaching for more, which may put those wants and wishes in jeopardy.

None of these principles will guarantee the highest returns. But applied consistently, they will give you the highest probability of achieving and maintaining financial security.

This story was originally published February 3, 2018 at 10:18 AM with the headline "Managing fear and greed is key to successful investment, even during bull markets."