How Emotional Decisions Can Ruin Your Investment Strategy

More money is left behind than lost during market declines. When an investor reacts emotionally to declines, they often pull money out of the market, derailing their investment strategy and leaving them much less exposed to equity markets. Often, these moves are made very near the bottom of the market and the investor leaves behind a substantial portion of return.

This year, the S&P 500 raised the hopes of many by climbing more than 7.5% by January 26 and then dashed them by falling more than 10% in the next 13 days. When the S&P 500 approached the 10% threshold, some investors became nervous and reduced risk by selling stocks and going to cash or bonds.

This is the point where they started leaving money behind. Rather than continuing to drop, the S&P 500 has risen 8.1% since then and may well rise higher. The challenge is once an investor derails their investment strategy and reduces their allocations to stocks, they don’t have a method for determining when to get back in.

This isn’t a new problem. I can remember investors in the fall of 2009 talking about how the market had “stabilized” and it was time to get back in. The S&P 500 had risen more than 56% from the market low. Markets had been anything but stable; yet, investors were trying to minimize the regret of abandoning a portfolio of diversified investments for cash and paying the price.

Rather than pulling money out of a portfolio of diversified investments, a better approach might be using asset allocation strategies designed to manage or reduce risk during significant market declines. These approaches reassure investors portfolios are being adjusted to reduce risk, while benefiting from a systematic risk-managing approach that ensures minimal return is left behind.

We see these strategies as potentially more beneficial to clients trying to balance an asset allocation in retirement. When a person can’t extend their career or increase retirement contributions, the ability to recover from downturns becomes a bigger challenge. In a low-income environment, using systematic approaches to risk management can manage the downside without relying on the still-paltry income provided by bonds.

Now seems like a good time to reassess risk. If you were able to hold on during the last decline but don’t want to experience something like that again, the recent rally has put you close to even. The regret of making a change now will likely be low. Most importantly, your portfolio will be better prepared for the next sharp downturn.

Asset allocation, which is an investment strategy driven by complex mathematical models, cannot eliminate the risk of fluctuating prices and uncertain returns, and should not be confused with the much simpler concept of diversification.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.