Steve Wendel, head of behavioral sciences at Morningstar, has some suggestions on how not to make rash decisions in a volatile market.
We all know the advice is generally don't look at your portfolio when the market free falls, but that's really hard to do, right? Is that something we could reasonably expect investors not to check their portfolio when you see this much volatility?
First, that is good advice.
There's lots of research on how frequently checking your portfolio, especially during market downturns, can warp one's behavior and get you into trouble. But we're all human. I've been looking at my portfolio as well throughout the day, just out of curiosity.
Thankfully there are a variety of great techniques we can employ to help us calm down and get back to our rational selves.
The first one is to remember that our minds play tricks on us. That, fundamentally, volatility, downward or upward, is just data. As for the drop that just happened, that's past. That's gone. There's nothing we can do about what just happened. It's really as we think forward to what will happen that our minds take that data and apply a story. If you don't know what that story is, it's probably the bias of recency bias--thinking that what just happened is about to happen. But when we think about that rationally, we of course know that's not the case.
One of the things that we can do is to round out that story: This just happened; this is what I believe is about to happen; what's the rightful thing to do? For most professional, thoughtful investors, they know it means you look for bargains. Same exact data. Very different outcome.
Let's say that you are prepared for that, but we do see a further sell-off. There's more volatility. Is there anything you can do now to prepare yourself for that happening in the future? You could be looking for bargains for quite a while.
Yes. Absolutely. The number-one rule is to externalize. It's to get it out of your head and take your calm, thoughtful decisions now to help guide you in the future. Now a variety of ways you can do that.
One of the ways you can do that is to intentionally look for friction, so if you're working with an adviser or just with yourself say, set a rule for yourself. I'm going to have a three-day waiting period before I make any change. For example, if you're working with an adviser tell him or her that they should only make a trade if you and your spouse are there. Think of ways that you can slow yourself down from making hasty decisions.
Other techniques you can use, of course, are to write out the rules you want to follow: only if the market drops by this percentage in a particular amount of time. And then you're checking those rules again and again rather than checking your portfolio and making up the story about how bad things are going to happen.
Some other techniques you can use are to look at the emotional power of your investment policy statement. Look at what you wrote for yourself--or if you haven't already written one, of course, you should do that. Write out not just what your financial goals are but why you care. What matters to you and how that expresses who you are. Then, in times of trouble, you look back at that and say, fundamentally what I care about, what I value, has it changed? Probably not. It's a counterpoint to the vivid, crazy stories that can go in our heads when we see a market downturn.
Of course, it always makes sense to separate the real world and your real life versus your portfolio. Particularly if you have 20, 30 years to retirement.
Exactly.
So the challenge is how do we fight vivid with vivid? We get these vivid images of a market crash, etc., but really it's only one of the things that we can pay attention to. Think about what does this mean for your goals? Probably not too much and especially in a 20-, 30-year horizon. What are the other things you have to do in your life? Play with your kids, help your family, do your job, etc. So you balance that one vivid screaming thing over here with all the other things you have to do in your life. It can help put things back in perspective.
This discussion initially appeared on Morningstar.com
