5 Ways to Keep Your Emotions in Check When Investing | American Funds

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Creating a Financial Plan

JUNE 19, 2017

5 Ways to Keep Your Emotions in Check When Investing

It's natural to feel emotional about investing, but making emotional decisions can devastate your portfolio. In fact, research shows that individual investors' returns lag the market mainly due to misguided actions.

Case in point: According to Dalbar's 2017 Quantitative Analysis of Investor Behavior, the average annualized return for Standard & Poor's 500 Composite Index* over the last 30 years was 10.16%, but the average investor in equity mutual funds earned just 3.98%. The main cause for the whopping 6.18 percentage-point discrepancy: investor behavior.

"It's human nature to go toward things that make us feel good and run from things that make us feel pain," says Chris Cook, founder and CEO of Beacon Capital Management. The ups and downs of the market can trigger emotions that drive investors in and out of the market at precisely the wrong time.

Market declines can cause fearful investors to panic and sell when prices are low. They often stay out of the market and miss the benefits of any subsequent rally. On the other hand, long bull markets often instill a false sense of security, luring investors to buy more when prices are highest. The end result: Investors tend to buy high and sell low.

Individual results suffer when investors buy and sell at the wrong time, explains Charles Rotblut, the editor of the American Association of Individual Investors Journal. “They’re typically getting less return than they would have realized by simply buying and holding those mutual funds.”

Fortunately, you can learn to control short-term market jitters. These five steps can help you avoid the pitfalls of emotional investing.

1. Have a game plan.

It’s important to craft an investment plan that meets your goals, time frame and risk tolerance. Diversify your holdings, for instance, so you’re not dependent on any specific asset class.

“We call it rules-based investing,” Chris says. “Having a solid plan helps tune out all the background noise.” If you are confident that your portfolio is appropriate for your long-term goals, you'll be less tempted to try timing the market.

2. Take a history lesson.

Market cycles are a fact of life. Over the last century, the stock market has endured wars, recessions and natural disasters but has bounced back each time.

Investors have witnessed multiple market declines since the 2008 financial crisis, from the "Flash Crash" of 2010 to the 2016 Brexit selloff. Yet after each event, the S&P 500 not only recovered its losses, it went on to post larger gains. Investors who cashed out missed those turnarounds.

3. Invest in good times and bad.

Establishing a consistent plan of investing can help you fight the urge to make changes based on short-term market fluctuations.

Instead of dropping a lump sum into a particular investment all at once, you can invest gradually, in smaller increments. Invest in fixed amounts at set periods of time, regardless of market volatility.

With dollar cost averaging, you purchase more shares when prices are low, and fewer when they are high. Over time, this strategy can lower the average share price you pay.

4. Don’t look at your portfolio too often.

Technology makes it easy to constantly monitor your investments, but checking your portfolio frequently can tempt you to make imprudent investment decisions. In fact, research conducted by Columbia Business School professor Michaela Pagel found that doing so habitually can lead to weaker returns.

“History has shown us that the stock market is a relatively safe bet over the long term because it has typically grown,” Pagel says. “Investors would be wise to keep this in mind, because those who check their portfolios too often and are driven by the daily or hourly fluctuations in the market may make decisions that have a negative impact on their long-term financial prospects.”

5. Work with a financial advisor.

Think of your advisor as your “financial physician,” says Meir Statman, the Glenn Klimek professor of finance at Santa Clara University’s Leavey School of Business, and the author of the book, Finance for Normal People: How Investors and Markets Behave.

Your advisor’s proverbial bedside manner can be invaluable. A good advisor can be empathetic and wise, providing calming words during periods of market volatility, as well as a historical perspective that might dissuade you from making rash decisions.

"An advisor might say, 'I understand how you feel, but here are some financial facts about the long-term performance of stocks,'" Meir observes. "You’re better off not making hasty decisions."

Once your advisor has helped you develop a long-term plan designed to endure through market cycles, you may be less distracted by short-term blips. Adhering to your plan, rather than acting on your emotions, can make investment success more likely.

*The market index is unmanaged and, therefore, has no expenses. Investors cannot invest directly in an index. The Standard & Poor’s 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2017 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.

"It's human nature to go toward things that make us feel good and run from things that make us feel pain," says Chris Cook, founder and CEO of Beacon Capital Management. The ups and downs of the market can trigger emotions that drive investors in and out of the market at precisely the wrong time.

Market declines can cause fearful investors to panic and sell when prices are low. They often stay out of the market and miss the benefits of any subsequent rally. On the other hand, long bull markets often instill a false sense of security, luring investors to buy more when prices are highest. The end result: Investors tend to buy high and sell low.

Individual results suffer when investors buy and sell at the wrong time, explains Charles Rotblut, the editor of the American Association of Individual Investors Journal. “They’re typically getting less return than they would have realized by simply buying and holding those mutual funds.”

Fortunately, you can learn to control short-term market jitters. These five steps can help you avoid the pitfalls of emotional investing.

1. Have a game plan.

It’s important to craft an investment plan that meets your goals, time frame and risk tolerance. Diversify your holdings, for instance, so you’re not dependent on any specific asset class.

“We call it rules-based investing,” Chris says. “Having a solid plan helps tune out all the background noise.” If you are confident that your portfolio is appropriate for your long-term goals, you'll be less tempted to try timing the market.

2. Take a history lesson.

Market cycles are a fact of life. Over the last century, the stock market has endured wars, recessions and natural disasters but has bounced back each time.

Investors have witnessed multiple market declines since the 2008 financial crisis, from the "Flash Crash" of 2010 to the 2016 Brexit selloff. Yet after each event, the S&P 500 not only recovered its losses, it went on to post larger gains. Investors who cashed out missed those turnarounds.

3. Invest in good times and bad.

Establishing a consistent plan of investing can help you fight the urge to make changes based on short-term market fluctuations.

Instead of dropping a lump sum into a particular investment all at once, you can invest gradually, in smaller increments. Invest in fixed amounts at set periods of time, regardless of market volatility.

With dollar cost averaging, you purchase more shares when prices are low, and fewer when they are high. Over time, this strategy can lower the average share price you pay.

4. Don’t look at your portfolio too often.

Technology makes it easy to constantly monitor your investments, but checking your portfolio frequently can tempt you to make imprudent investment decisions. In fact, research conducted by Columbia Business School professor Michaela Pagel found that doing so habitually can lead to weaker returns.

“History has shown us that the stock market is a relatively safe bet over the long term because it has typically grown,” Pagel says. “Investors would be wise to keep this in mind, because those who check their portfolios too often and are driven by the daily or hourly fluctuations in the market may make decisions that have a negative impact on their long-term financial prospects.”

5. Work with a financial advisor.

Think of your advisor as your “financial physician,” says Meir Statman, the Glenn Klimek professor of finance at Santa Clara University’s Leavey School of Business, and the author of the book, Finance for Normal People: How Investors and Markets Behave.

Your advisor’s proverbial bedside manner can be invaluable. A good advisor can be empathetic and wise, providing calming words during periods of market volatility, as well as a historical perspective that might dissuade you from making rash decisions.

"An advisor might say, 'I understand how you feel, but here are some financial facts about the long-term performance of stocks,'" Meir observes. "You’re better off not making hasty decisions."

Once your advisor has helped you develop a long-term plan designed to endure through market cycles, you may be less distracted by short-term blips. Adhering to your plan, rather than acting on your emotions, can make investment success more likely.

*The market index is unmanaged and, therefore, has no expenses. Investors cannot invest directly in an index. The Standard & Poor’s 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2017 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.

"It's human nature to go toward things that make us feel good and run from things that make us feel pain," says Chris Cook, founder and CEO of Beacon Capital Management. The ups and downs of the market can trigger emotions that drive investors in and out of the market at precisely the wrong time.

Market declines can cause fearful investors to panic and sell when prices are low. They often stay out of the market and miss the benefits of any subsequent rally. On the other hand, long bull markets often instill a false sense of security, luring investors to buy more when prices are highest. The end result: Investors tend to buy high and sell low.

Individual results suffer when investors buy and sell at the wrong time, explains Charles Rotblut, the editor of the American Association of Individual Investors Journal. “They’re typically getting less return than they would have realized by simply buying and holding those mutual funds.”

Fortunately, you can learn to control short-term market jitters. These five steps can help you avoid the pitfalls of emotional investing.

1. Have a game plan.

It’s important to craft an investment plan that meets your goals, time frame and risk tolerance. Diversify your holdings, for instance, so you’re not dependent on any specific asset class.

“We call it rules-based investing,” Chris says. “Having a solid plan helps tune out all the background noise.” If you are confident that your portfolio is appropriate for your long-term goals, you'll be less tempted to try timing the market.

2. Take a history lesson.

Market cycles are a fact of life. Over the last century, the stock market has endured wars, recessions and natural disasters but has bounced back each time.

Investors have witnessed multiple market declines since the 2008 financial crisis, from the "Flash Crash" of 2010 to the 2016 Brexit selloff. Yet after each event, the S&P 500 not only recovered its losses, it went on to post larger gains. Investors who cashed out missed those turnarounds.

3. Invest in good times and bad.

Establishing a consistent plan of investing can help you fight the urge to make changes based on short-term market fluctuations.

Instead of dropping a lump sum into a particular investment all at once, you can invest gradually, in smaller increments. Invest in fixed amounts at set periods of time, regardless of market volatility.

With dollar cost averaging, you purchase more shares when prices are low, and fewer when they are high. Over time, this strategy can lower the average share price you pay.

4. Don’t look at your portfolio too often.

Technology makes it easy to constantly monitor your investments, but checking your portfolio frequently can tempt you to make imprudent investment decisions. In fact, research conducted by Columbia Business School professor Michaela Pagel found that doing so habitually can lead to weaker returns.

“History has shown us that the stock market is a relatively safe bet over the long term because it has typically grown,” Pagel says. “Investors would be wise to keep this in mind, because those who check their portfolios too often and are driven by the daily or hourly fluctuations in the market may make decisions that have a negative impact on their long-term financial prospects.”

5. Work with a financial advisor.

Think of your advisor as your “financial physician,” says Meir Statman, the Glenn Klimek professor of finance at Santa Clara University’s Leavey School of Business, and the author of the book, Finance for Normal People: How Investors and Markets Behave.

Your advisor’s proverbial bedside manner can be invaluable. A good advisor can be empathetic and wise, providing calming words during periods of market volatility, as well as a historical perspective that might dissuade you from making rash decisions.

"An advisor might say, 'I understand how you feel, but here are some financial facts about the long-term performance of stocks,'" Meir observes. "You’re better off not making hasty decisions."

Once your advisor has helped you develop a long-term plan designed to endure through market cycles, you may be less distracted by short-term blips. Adhering to your plan, rather than acting on your emotions, can make investment success more likely.

*The market index is unmanaged and, therefore, has no expenses. Investors cannot invest directly in an index. The Standard & Poor’s 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2017 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.


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