Ten years ago everyone was running after the next hot tip. The stock market was generating double digit yearly returns and the share prices of companies like Qualcomm and Intel seemed to be doubling overnight. Greed was running rampant in the psyche of investors, and no one wanted to miss out on the next hot stock.
Fast forward to today, and everyone seems to be running for cover. The S&P 500 Stock Index is LOWER than it was ten years ago and the economy is mired in a deep recession. Fear is rampant and the safest place to invest your money is under your mattress, or so it seems.
As many investors are finding out, the fickle stock market can wreak havoc on our emotions of fear and greed, especially when we tune in to it on a daily basis to monitor our account balances. When times are good, we tend to get overly optimistic about the future, and when times are bad we are probably a little too despondent.
It would be nice if the stock market returned about 10 percent a year. On average, it does. Unfortunately, year over year the reality is very different. More often than not the yearly returns on the stock market are either significantly higher or lower than 10 percent. It is called volatility, and it has to do with the risk and reward characteristics of investing in common stocks.
That is why we invest in the stock market in the first place. We are willing to endure the short-term risk inherent in that asset class in pursuit of higher long-term returns.
With that in mind, is it possible to control our emotions of greed and fear when investing in the stock market, so we don’t end up with 100 percent of our portfolio invested in common stocks at market peeks, only to find ourselves 100 percent in treasury bonds at market bottoms?
The first step to controlling your emotions of fear and greed is to develop a financial worksheet and corresponding asset allocation plan that fairly represents how your assets are allocated between stocks and bonds based on where you are at in your life.
This document should include an analysis of the inevitable market declines, and how this scenario is likely to impact your current lifestyle. Then, when the market does experience such a decline, you are more likely to stay committed to your allocation plan and not put all your money under a mattress at market bottoms.
Just as important, when stock market experiences the euphoria of ten years ago, you are more likely to rebalance out of common stocks and into safer, short-term investments like bonds or CDs to protect yourself from future stock market declines.
Bull and bear markets are part of the investing cycle. Don’t let your emotions get in the way of a smart financial plan to see you through these volatile markets.