Often, we become our own worst enemy with our portfolio. The natural human tendency is to chase stocks moving higher and sell stocks moving lower, when the reverse is usually the more fruitful strategy. Then, when their account value declines, investors doubt themselves.
So, how can we be our own biggest advocate with our investments? There's no denying that investing can be difficult, and market timing is even harder. What can you do? Here are three actions you can implement in your regimen right away, especially during challenging times.
Be aware of your biases
Many of us are oblivious to our shortcomings, but simply being aware of them can help you get out of your own way. Many drivers, for example, believe they are above-average on the roads, and many investors believe they can generate alpha, or beat the major benchmarks, such as the S&P 500. But it would be impossible for most drivers and most investors to be better than average.
This doesn't mean investors can't beat the major benchmarks. It simply means that it's important to invest with an understanding of one's potential biases, false beliefs, and blind spots.
Regardless of the market environment, biases such as herding and fear of missing out (FOMO) impact investor decisions. They refer to the habit of adopting certain behaviors or beliefs because many other people do the same. Investors popularized this concept in early 2021, pushing up the share price of meme stocks, or shares of a company that have gained a cult-like following online and through social media platforms.
Another bias is action bias, which describes our tendency to favor action over inaction. Sometimes, we feel compelled to act, even if there's no evidence that our action will lead to a better outcome than doing nothing would. Humans tend to act as default. For example, when markets move lower, the human tendency to act – often to sell – settles in, when in reality, staying in the market long-term generates more return over time.
The bottom line: It could be worthwhile to step back and reflect on the potential biases that could be impacting your ability to think clearly about your portfolio.
Understand that market cycles are natural
Mostly because of investor psychology, markets generally swing toward or back from one extreme or the other. There are natural cycles, back and forth, often between extremes.
Sometimes, it's helpful to think of the overall market like a swing set. For instance, we swung from a bull market in 2019 to a vicious bear market in March 2020. Then we swung to a bull market for the rest of 2020 and through 2021, only to swing back to a bear market this year.
The bull-to-bear-market flow often begins when a few prudent people think things will get better. Then many investors realize improvement is taking place, and then everyone concludes things will be great for a long time, taking on more risk when they probably should be reducing it.
Stock market cycles have typically anticipated economic cycles by six to 12 months on average. The cycles are familiar--the economy expands and contracts and the markets rise and fall.
Entering investments with this knowledge in mind can help prepare for the inevitable ups and downs. Remember, markets are defined by an ever-evolving cycle. And remember, it's helpful to understand the cycle so you know where your investments might be in the bull-bear swing set. This also may mitigate the effect emotions might have on your decision-making.
Stick to your plan
While long bear markets leave most investors with limited options, they also present time to rebalance and tinker with strategies. Time to practice remaining calm and humble. Time to practice not panicking or compromising our health. For longer-term investors, the best option in these markets is often to do nothing but take long walks, learn, study, and catch up on your reading.
Sticking to your plan might mean not checking your portfolio every day, especially in downturns. We can be masters of self sabotage, and loss aversion implies that losing money hurts more than the satisfaction of gaining it.
Or, sticking to your plan could mean refreshing yourself with financial literacy and basic concepts to drive the point home. Routines such as reading your favorite investing books, Motley Fool articles, and listening to your favorite financial educational podcasts can steer you in the right direction.
Another time-tested method: To remove emotions from investing, set boundaries such as not allowing yourself to buy a stock within an hour of the market open, or within an hour of watching financial television. Every little bit helps.
Taken together, these three strategies could help you stay out of your own way and improve your financial fitness.