My Brain Made Me Do It!
If you're thinking about the 2008 bear market - and the alarm you may have felt as you watched the markets lose value - you may be relieved to know that your reaction was only human. In fact, there is an entire body of scientific evidence that the human brain tends to respond in fairly predictable ways to moments of extreme stress. That's why it is so important to have a strategy for dealing with market volatility - and a plan of action to keep you on track.
Walking, breathing, feeling and reasoning seem like they should be automatic. You trust your brain to keep these processes running smoothly - and most of the time it does. However, there are times when the different parts of your brain operate on their own. For example, in moments of intense emotion, the reasoning part of your brain shuts down completely. Your brain senses the need for survival and all the blood flows to the other parts of the brain that keep you alive. That's not such a bad thing if you encounter a bear on a walk through the woods, but it may not work as well when the bear you meet is in the stock market instead.
WHEN EMOTION TRUMPS LOGIC
There are also times when your brain is hard wired to have a particular emotional response to a situation - including investing. These common tendencies, also referred to as biases, have the potential to steer you wrong unless you recognize them in advance.
Most investors are more upset at losses in their porfolios than they are excited by gains. Next time the market declines significanatly, refer back to the long-term plan that you established. Remember, losses incurred over the short term are often offset by gains over the long term with a properly diversified portfolio.
It is easier to overcome loss aversion if you can keep the bigger, long-term picture of investing in mind.
You can't control the market - or avoid the downturns. But if you understand the way your brain works. and the biases that can work against you, you can keep your long-term investment goals on target by working with your advisor. A little planning in calmer times can go a long way to help you when the market winds kick up again.