Don't let your emotions rule your investments

world economyThe recent slew of negative economic news has sent the financial markets into a tailspin. From China's surprise devaluation of their currency and concerns about global growth to Greece's economic woes and the fear of a rate hike by the Federal Reserve, many factors have contributed toward the spike in volatility.

If you are like many investors, declines in the value of your investments can leave you with an uneasy, anxious feeling, especially if you are nearing retirement or already retired.

While the fluctuations in the market definitely warrant a re-examination of risk and your financial planning goals to determine if a change is needed, overreacting and allowing your emotions to rule your investment decisions can be detrimental to the achievement of your long-term financial goals.

The Behavior Gap

So why do investors panic in the first place?  It's pretty simple – when the unexpected occurs, it can be human nature to want to run for the exits - especially when you are talking about finances.

The problem is that making the wrong investment decisions at the wrong time can lead to what is referred to as the behavior gap (a popular concept in finance to describe how emotions can negatively impact investment returns).

Whether it be chasing returns and buying high or bailing on a long-term investment strategy and selling low, investors may implement destructive behavior when making investment decisions - especially when things get emotional.  Bottom line - trying to time the market can make things worse for the average investor, so do your homework prior to making any sudden changes.

Make sure your portfolio is compatible with your goals

Markets do not just move in one direction – it is perfectly normal for there to be increases and decreases in value.  In fact, this ebb and flow has been occurring for years and market corrections (defined as a decline in value of between 10 and 20 percent), as unpleasant as they may be, can occur on a fairly regular basis.

According to Bloomberg, corrections occur approximately every two years on average.  While it would be nice if markets didn't decline in value, investors that are not comfortable with negative returns from time to time may want to take a step back to assess whether their portfolio is congruent with their financial plan.  The problem is many investors fail to complete a comprehensive financial plan, let alone update it year after year.

Tune out the market noise

Sure, educating yourself on finance and the global economy is a great idea.  Improving your financial literacy is critical.  However, constantly tuning into the financial media during a crisis can lead to intense emotions and impulsive decision making, so be careful to avoid the financial media feeding frenzy that often occurs when markets decline.

Avoid rear-view investing

Additionally, some investors allow past performance rather than their investment goals and time horizon, to dictate their portfolio allocation.  For example, choosing to adjust your allocation to be more aggressive simply because the market may have performed well in the past or suddenly becoming more conservative due to recent market declines.

Be careful when using the rear-view mirror approach when selecting investments.  Remember, past performance is no indication as to future returns.

Review your risk tolerance

In an effort to reach for potentially higher yields, the low yield environment has also caused some investors and retirees to take on more risk than they might otherwise be comfortable with.

Rather than choose investments solely on return, investors should consider relying on the development of a financial plan that takes into consideration your risk tolerance, time frame, tax impacts and cash flow needs when determining the most appropriate allocation.

For investors with sufficient time to recoup losses, volatility may actually end up being beneficial in the long run.  Consider continuing to systematically add to retirement accounts like 401(k)s  and IRAs during volatile times and re-visit your savings plan on a regular basis. Please keep in mind that this type of plan does not assure a profit and does not protect against loss in declining markets.

Also consider focusing on the areas you can control such as your budget and how much you are able to save as this may help you work towards your goals despite the increase in volatility.

Allowing emotions to impact investment decision making can cloud judgment.  While it may not be advisable to make sudden adjustments to your investment plan, some circumstances may warrant a change.  Please remember that investing does involve risk and no strategy can assure success or protect against loss.  The information noted is for general purposes only and not intended to provide specific advice or recommendations.  Since everyone's situation is unique consider speaking to your tax and financial adviser to determine an appropriate approach for you.

Kurt J. Rossi, MBA, is a Certified Financial Planner Practitioner & Wealth Advisor.  He can be reached for questions at 732-280-7550,  - LPL Financial Member FINRA/SIPC.