In Today's Hot Market, Better Keep Your Cool
When stocks are soaring, your natural impulse is to take action. Problem is, that impulse is usually wrong.
(Money Magazine) -- Had enough of the gloom and doom in the news these days? Then check out the business section.
There the tone is decidedly upbeat thanks to the stock market's performance since the summer. "Dow Breaks Record." "S&P Hits Six-Year High." "Dow Sets Another Record."
In fact, when I Googled "Dow record 2006" in mid-December, I came up with 2.1 million hits in 0.16 seconds. All this talk about records is likely to make you react in one of two ways.
Which of these camps do you fall into?
a) This is great. Stocks are rolling again. I've got to get in on the action big-time.
b) Uh-oh. I've seen this before. Time to bail.
I have to confess that I tend toward the latter. When bonus pay for Wall Street firms scales new heights (as it did in 2006) and there's not a lot of uninvested cash sitting in mutual funds (as there isn't now), and when survey after survey points to rising investor optimism (as has been happening lately, I start getting nervous that we have reached the top and that the fall could hurt.
But as someone who's been immersed in the world of money for going on two decades, I've learned that when your inclination is to jump in or out of the stock market with both feet, you are better off just taking a deep breath and going for a jog (or at least for a walk around the block).
Let me explain.
No one can make market risk go away. It can't be done. For all the times that you're scared, there will be just as many when you feel almost giddy. Either state of mind is a terrible one in which to make a major decision about your investments.
What you're feeling is a lack of control, and the way to get it back is not via a rash commitment that you'll only come to regret later. Instead, put some provisions in place that will keep your emotions from controlling you.
Here are some examples.
Brett N. Steenbarger, a clinical psychologist and author of "Enhancing Trader Performance," explains that when we humans experience a powerful emotional event (and a big gain or loss in our wealth, even if it's just on paper, is one), our brains don't work the way they do when we're calm.
During times like these, the analytical part of the brain shuts down, Steenbarger explains.
So create a plan to keep yourself on the straight and narrow even when your brain fails you.
My advice: Dollar-cost average into the market month in and month out through your company's retirement plan or an automatic investment plan with a brokerage firm.
If stocks go up, hey, great. If they go down, that's fine too. You're buying at cheaper prices.
And if your 401(k) offers automatic rebalancing to maintain your chosen asset allocation, by all means sign up for it. That'll help keep you from deciding, in the heat of the moment, to make drastic changes to your portfolio.
Quit aiming for perfection
You'll be much better suited to investing (and come to think of it, to most other things in life) if you get over the impulse to try to nail it. Years of research by Terrance Odean, a finance professor at the University of California at Berkeley, show that individual investors tend to do themselves far more harm than good when they muck with their portfolios.
On average, if they buy one stock and sell another, the one they sell goes on to do better than the one they buy. And those who try to time the market do worse, on average, than those who don't.
Odean's recommendation: Let's not and say we did. "My advice is simply not to try to time the market. The average investor should buy well-diversified mutual funds that are fairly low cost," he explains.
And then he suggests taking a truly long view. "Say to yourself, 'I'm investing for 20 years or 30 years, so I don't have to worry about getting it perfect this year. I don't have to worry about getting it right today.'"
Get help if you need it
Look, if you were worrying about your heart, your marriage or your career, you'd very likely find someone - a cardiologist, a therapist, a coach - to help you. A good financial adviser can, at the least, prevent you from doing yourself harm.
"There are times in our lives where we need someone else who will let you bounce ideas off them," says psychologist Frank Murtha, managing partner of Market Psychology Consulting. "If left to our own devices, we are often too susceptible to our own biases and bad ideas."
Go to the movies
Or out to dinner. Or on that jog I mentioned. Stop paying so much attention to the daily movements in your portfolio, and focus a little more on your life.
"It's unfortunate but true," Murtha notes. "But studies indicate that people who analyze their portfolios more frequently get too consumed with short-term statistics, and that's bad for the long term. You don't have to look at the value of your retirement account every day or even every other."
Exercising every other day, on the other hand - now that's a bandwagon I can definitely get on.
And you know something? When I'm out for one of my four-mile runs, my portfolio is the last thing on my mind. That's good for me and for my money.