We all know that to receive a return on your investment, first you must invest and then, you must stay invested. Investing 101 teaches us that risk and return are related – to earn returns, you must put your assets at risk in ventures that are expected to compensate you for your faith that they will succeed. The amount of potential return is directly correlated with the amount of risk you assume. As an investor, you must patiently await the desired outcome, knowing that success is expected but not guaranteed.
As you wait, the market moves up and down, sometimes in extremes, which can make it very difficult to trust that, despite what is happening over any given day, month, or year, the market will continue to do what it has done for many decades when viewed from a long-term perspective: It has grown.
So, instead of waiting, many investors panic when the markets become volatile and move their money to the proverbial sidelines. They also fret that they’re going to miss the boat when the market surges, so they pile into whatever is the latest success story. By chasing and fleeing hot and cold markets, investors are undesirably buying high and selling low – not a recipe for investment success. They are also disregarding decades of empirical evidence that informs us that one of the best ways to capture long-term market growth is to build a solid, individualized plan, and to then stick to that plan by riding out the market’s near-term ebbs and flows.
So, why is it that so many investors ignore this common-sense strategy – invest and stay invested – and instead cut the cord during turbulent times? While the strategy is simple to understand, it can be difficult to endure – plummeting markets and tempting trends can test those with the strongest of convictions.
Behavioral finance informs us that, thanks to our most basic instincts, we are subjected to a host of financially damaging biases – loss aversion (fear of losing money), recency bias (remembering most clearly what happened most recently), herd mentality (following what others are doing and saying) and many others – that lead us astray during these sorts of volatile market conditions. In attempting to protect ourselves, we end up doing more harm than good.
This is why you want to prepare for your investment leaps well in advance, with your adviser at your side, to help you maintain your resolve. A pre-determined, yet flexible plan and investment strategy will help you resist the urge to react. This will greatly increase your success in your quest for long-term investment success.