By Patrick Huey, CFP®, CAP®
Investors often become confused about what to do during a period of market weakness or downturn. The human bias toward action can work against their ultimate investing goals. This is confusing because taking action seems like a necessary step towards achieving any plan. Action can feel good, especially when things are going badly. If we just do something it will be better than sitting still and letting things run their course.
Our modern brains are sometimes helpless against the allure of doing, merely for the sake of saying we did something. Emotions reduce the cognitive load on our brains by triggering a call for action that is a pre-programed shortcut. They allow us to stop thinking and just react. If that sounds like it might not always be the best option, you are starting to get the point.
Action dispositions also override just about everything else the brain is doing at the time. They take precedence over other goals and objectives and block stimuli that might help alleviate how the emotion was created. Research firm Dalbar Inc. explored how such emotions affected investor performance. The results were startling: investors trailed all asset classes and even inflation over the past 30 years. (For more, see: How to Avoid Emotional Investing.)
This is because they use emotions as buy and sell signals, missing market performance while paying fees to do so. Many investors who attempt to properly time the market rely on their emotions, gut feelings or intuition to determine when to exit and re-enter. As the Dalbar study shows, most investors get this part wrong, leading to long-term underperformance.
Luckily, not everyone is equally vulnerable. As a long-term investor, you should expect obstacles, complications and adjustments to your plans. You can train yourself to adjust your plan (or don't adjust your plan) the right way. If you feel you must do something the next time the market swoons, here are several action items that you can do now.
Review Your Plan
A solid financial plan is based on historical data that includes numerous drops in the market. This is not something that comes out of the blue. It has happened before should be part of the design. No one builds financial planning software based on dodging each and every correction or bear market, because no one can do that on a consistent basis. More money is usually lost trying than in the actual downturn. Review the things you can control, like spending and saving. Make sure your assumptions are realistic. Take comfort in the fact that you have already thought this through rationally.
Consider Your Perspective
A lot of media coverage emphasizes the enormity of an event based on how long it has been since it last occurred. For instance, during the January/February 2018 correction, there were numerous stories about a particular trading day being the worst day for stocks since 2011. For perspective, try asking the question: "And then what?" Beginning in the year 2011, although there were corrections, the general trend approaching 2018 was upward. Just because something hasn't happened in a while doesn't indicate that it is unusual or indicative of something sinister. And if there is nothing unusual or sinister, why change what you are doing?
Adjust Your Positioning
If you must do something, go shopping. If there are things you wanted to own before a downturn but felt they were too pricey, modestly reposition yourself now that stocks have gone on sale. This does not mean changing the overall strategic allocation determined in the planning phase, but it could mean tactically swapping one stock or sector for another. But make sure it is really necessary. Consider performing a cost-benefit analysis. This four-step process includes: brainstorming costs and benefits, assigning values and financial estimates to costs, assigning similar values to benefits and finally, comparing the two to arrive at a decision.
Tallying the potential costs and benefits of your financial decisions is a good exercise to discover hidden expenses, ulterior motivations and emotionally-based decisions. And it may just be enough activity to satisfy your inner nomad. (For more, see: Understanding Investor Behavior.)
This article was originally published on Investopedia.