Written by Preet Banerjee
Friday, October 4th, 2019
Emotions often get in the way of achieving the returns available in a prudently constructed portfolio. Here are four articles that talk about creating a long-term investing philosophy that doesn't focus on the short term.
We're More Sensitive to Losses than We Are to Gains
While long periods of strong markets might tempt us to either start investing or turn up the risk in our existing portfolios, markets move in cycles.
We might have a tendency to get in near a cycle peak. That means we may experience losses in our portfolios soon after, and since we feel losses more acutely than gains, we may then turn around and sell near market lows. Stung by the losses, we might stay on the sidelines while the markets rebound over time. It's how our emotions can lower our investment returns.
Once again, only after the markets have shown strong returns do we start to think about getting back in. It's a vicious cycle. Instead of reacting to market cycles, we should accept them as reality and just stay invested.
Market Noise Preys on our Emotions
Focusing on headlines about short-term performance is a recipe for disaster for your portfolio. That's because the news tends to focus on short-term performance, which can be volatile, and that alarmist tone is what gets people to read articles. In other words, market noise.
But we know the price for higher potential long-term returns is short-term volatility. So there's no point in paying attention to headlines about daily market performance: they'll just make you second guess your portfolio.
Diversification is Your Friend
Many people are happy to "trade the chance of making a killing in exchange for never getting killed." That's part of the idea behind diversification.
By holding many different individual investments, over many different industries (like technology versus financials versus consumer goods), and over different countries and asset classes, you can reduce the volatility of your portfolio.
Some individual investments inside your portfolio may produce huge returns, but some other individual investments may suffer major losses. Since we can't predict which parts will do what, diversifying across many different investments can reduce the big swings in a portfolio.
Keep Your Eyes on the Horizon
It's important to have a long-term perspective on your investments because the shorter your perspective is, the more unpredictable the performance.
It's like learning to ride a bike. If you focus your eyes just in front of the bike, you'll be wobbling and likely to fall over. But looking down the path into the horizon leads to a smoother ride.
Having a Plan Can Help Control Your Emotional Response
An analogy that resonates with many is that having an investment plan is like planning a road trip: Few people would get into a car, start driving without a map, and just see where they end up over time.
Instead, establish where you want to end up first. Depending on the distance, that will help determine how long it might take to get there. Traffic or construction might crop up along the way, but you can recalculate your route and still end up where you want.
You could take a sports car with a firm suspension which might be jarring over the potholes along the way, or you could opt for the smoother ride of a full-size sedan. You can tailor your trip to your liking.
Whether it's a road trip or an investment journey, things don't always go according to plan. By having a plan in place, you'll be more confident and more likely to end up where you want.