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Keep Calm and Carry On: Behavioral Characteristics of Rational Investors

Keep Calm and Carry On: Behavioral Characteristics of Rational Investors

March 18, 2022

Does it sometimes feel like the sky is falling?  COVID rearranged our lives.  Just when we thought things would return to some normalcy, a major world power invaded its neighbor.  Inflation, gas prices, supply chain disruptions… Please! Make it stop!!

After an historically long bull market and relatively tranquil markets we’ve seen volatility come roaring back with a vengeance.

What is an investor to do?

If you work with a financial advisor, you’ve already had this conversation.  You’ve talked about your risk tolerance and your ability to sleep at night when the markets get rocky.  You’ve identified your time horizon- when you think you would need this money.  Your advisor put together a portfolio that is properly diversified (not all of your money concentrated in one area) and allocated per your risk tolerance (the ratio of stock and bond content).

You’ve agreed to stick with the plan (your portfolio). 

The market will do one of three things: it goes up, it goes down or it goes sideways.  We just don’t know the when. As an investor, you will likely experience the good, the bad and the ugly.

That’s where it gets tough, that ugly part.

The single most important thing your advisor will do is to prevent you from making emotional decisions (“fight or flight”) when you get spooked.  Your advisor will remind you of your time horizon (you have plenty of time to ride this out), your risk tolerance and your commitment to stay invested.  She will also explain to you why the market/your portfolio is acting this way.  With my own clients I’ve noticed that once they understand what is going on, my clients are more comfortable with the current volatility.

Imagine that you are on an airplane and it hits a patch of turbulence.  Instead of jumping out of the plane, you fasten your seatbelt, ride out the turbulence and eventually arrive at your destination. In your portfolio, you’ve identified your risk tolerance and time horizon, so now you just need to buckle up and wait for touchdown.

What does it take to be a rational investor?

Patience: Investing is a long-term endeavor.  Time can be your friend if you have a long-time horizon.  You have the luxury of riding the ups and downs of the market.  Time can also be your enemy.  If you don’t have a long-term horizon, your probably have some catching up to do.  Portfolios need time to grow.  Growth comes from dividend reinvestment and capital appreciation of the holdings. By reinvesting your dividends (from mutual funds & some stocks) you have more shares and if you have more shares, you earn more dividends. At the very least you should end up with more shares than you started.

Discipline: Investing requires that you stay invested. It has been well documented that it is not possible to time the market (jump in and out when you get scared or feel more confident).  Markets can turn around quickly and you could miss the upside if you’ve been sitting on the sidelines waiting for the “perfect” time to get back in.  Stay invested.

Courage: Volatility is scary but it is also normal. Stuff happens. It probably doesn’t help that there is a 24 hour news cycle that magnifies and over analyzes the current event.  Turn the TV off. Call your advisor to have her explain the current market conditions and how it impacts your portfolio.  Quiet the emotional part of your brain. Buckle up and ride it out.

Then there is the Sleep Test. If you truly cannot sleep at night because you are worried about the market, maybe it is time to reassess your risk tolerance.  Talk to your financial advisor to see if there is an alternative strategy for achieving your financial goals.