Tuesday, May 27, 2014
In many areas of your life, you’re probably aware that it’s useful to keep emotions out of your decision-making — and that’s certainly the case with investing. However, it can be difficult to keep your feelings from influencing your investment decisions. But you may find it easier to invest with your head, rather than your heart, if you know a little something about two different cycles: the market cycle and your emotional cycle.
Let’s start with the market cycle. If you’ve been investing for a while, you’re aware (probably highly aware) that the financial markets are rarely static — they are always moving up and down, at least in the short term. (Over the very long term, a period of many decades, the markets have trended up.) But these short-term movements, while perhaps appearing as “zigs” and “zags” on a daily basis, actually form a pattern, or a cycle, that can last for months or years. These cycles are known as bull (up) or bear (down) markets. Going back to the Great Depression, the average bear market has lasted 21 months, while the average bull market has extended for 57 months, according to research from Standard and Poor’s Index Services.
These market cycles greatly influence investors’ attitudes and behavior. In fact, they lead to the formation of investors’ emotional cycles. During bull markets, investors tend to feel optimism, excitement and even euphoria. But once a bull market ends and a bear market begins, investors start getting nervous. And the longer and deeper the bear market, the greater the depth of emotion felt by investors. These emotions can begin as anxiety and then progress to denial, fear, desperation and panic.
Furthermore, market cycles and emotional cycles don’t really align. For example, investors may well experience euphoria when the market has reached its high point and a bear market has just begun. For a while, then, these investors, fueled by their euphoric feelings over the big gains they’ve achieved, may continue pouring money into the market, even as it’s declining. This type of behavior, though, is probably better suited for when the market is already at a low, when investors’ dollars will buy more shares. Conversely, investors may reach the peak of their fearfulness at the end of a bear market, just when things are about to turn around. At this point, their fear may hold them back from investing — even though, with prices low, it can be a good time to invest. Clearly, basing investment decisions on emotions can lead to poor choices.
So don’t get caught up in this pattern. Instead, strive to follow a disciplined approach to investing. Build an investment portfolio that reflects your objectives, risk tolerance and time horizon, and seek to hold appropriate investments for the long term. Of course, you may well need to make adjustments along the way, but do it for the right reasons — such as a change in your goals or in the investments themselves — rather than as a reaction to the current market cycle.
Our emotions are powerful, and their power can increase when applied to such a meaningful aspect of our life as our finances. But if you can detach yourself, as much as possible, from the emotional cycle of investing, you can avoid considerable angst — while helping clear the path to pursue your goals.
-Financial Focus is provided courtesy of Edward Jones, Brian K. Bliesner, Financial Advisor.