Don’t let Fear Manage Your Money

Don't let Fear Manage Your Money

What originally motivated you to start investing?  Was it saving for a big purchase, saving for your children's education, or just the dream of finally having financial freedom? Then why do so many of us let fear make our investment decisions?

While everyone knows the old saying, "buy low, sell high" it often isn't as easy as that. What if you missed the low? Do you try and time the next market bottom? Do you invest after the market has gone up again? How do you know when to buy and sell?

According to Dalbar's Quantitative Analysis of Investor Behavior (QAIB), the average mutual fund investor had a 4.79% return over the 20 year period ending in 2016 while an index portfolio made up of 60% stocks and 40% bonds would have returned 7.16%.  What causes this difference?

Fear Factor

Every intro to finance class will teach you that markets are rational, but it turns out investors are often irrational and make investment decisions based on their emotions. The biggest emotional response comes with fear.

Fear of Missing Out - The fear of missing out occurs in markets we are in today. Amazon and Google are trading near $1,000, the market is soaring to all time highs. Investors that missed out on the party, pour all of their funds into stocks. They then end up taking on too much risk and buying at the top of the market just in time for the current business cycle to end.

I remember encountering this fear personally in college. The tech bubble of the late 90's and early 2000's was in full force and I was worried that stocks would keep going up and leave me behind. Fortunately, I didn't have much money to lose, but what little I did have took a dive when valuations came crashing down in 2001. I learned my lesson that despite everything I thought I knew from class got foggy when my own emotions were involved in my decisions.  

Fear of Loss - This fear often accompanies the fear of missing out. Take the average investor during the financial crisis of 2008. Let's call him Mark. Stocks start falling and Mark loses 10%, 20%, 30% and is losing sleep worried about the financial position he is in. Ultimately, he sells near the bottom when the recession ends and waits a year or two before starting to slowly invest again.

This fear hits even the best of us that believes we are the most level headed because no one likes to lose money. What compounds the problem is the cycle it creates and the fact that Mark is primed to chase the new highs to make up for not being invested in the early years of the recovery.

Getting Over Your Fears

• Know that you will lose money - If you can't handle losing money you shouldn't invest in the market.  Decide on how much you can handle losing and on how much risk you are willing to take.
• Have a plan and write it down - Those that write down their plan are likely to see it through. It is easy to stick to the plan when times are good, but much tougher in the middle of a recession. Your plan should detail how much you plan to invest per year and for how long. It should also include how much you will be investing in stocks, bonds, real estate or anything else. Having a written plan is a compass in the middle of a storm.  
• Don't Try and Be a Hero by Timing the Market - Don't try to pull all of your money in and out of the market before a crash. It is impossible to time and leads to the exact fears discussed above. Instead, document in your plan that you will only allow yourself a 5-10% shift in your portfolio. This can still have a big impact and keeps you focused on the plan. This should only be done every few years as investment valuations change during the business cycle rather than changing your strategy  according to daily market movements.     
• Have a Safety Net - What if I told you, you could achieve stock like investment performance with less risk.  That is the benefit of diversifiers.  Bonds and to a lesser extent real estate, commodities, and TIPS all help to lower the risk of a portfolio.  Keeping even 10-20% of these in your portfolio can make a noticeable difference in your account fluctuations while still allowing your investments to grow. 
• Get Help -  An investment advisor can help you stay on track by taking these changes out of your hand and managing your investments to the exact written specifications you agreed to in the beginning. This takes the emotion out of it and instead puts the focus on the process.