Back to (investing) school

Summer is ending, and you know what that means: It’s time to go back to school.

Investing is largely mental, after all. Markets are constantly changing, and your ability to process and adapt to change can make or break your portfolio. 

Even if you pick stocks like a pro, you may find yourself managing your emotions more than your portfolio. And your brain rarely works in your favor when it comes to investing.

Don’t get intimidated, though. You can easily prep your brain with a little time and intention.

Class is in session.

Take small steps

Vacation is over, and you’ve got a long list of things to do.

Even worse, there seems to be a lot of pressure on your portfolio. Volumes are picking back up, and the economic outlook feels murkier than ever. You may have to fight some fall-itility, too. September has been (on average) the S&P 500’s worst month of the year since 1950, and October has been the stock market’s most turbulent month over that same period.

If you’re feeling overwhelmed, you’re not alone. No matter if you’re a long-term investor or a short-term trader, you may have to weather some tough storms over the next few months.The lesson: Timeframes matter a lot in investing, and there are significant benefits to starting early and investing for years (mainly, the power of compounding returns over long periods of time). But we often forget that long-term views are just a series of short-term views. 

Check that first box on your to-do list and ride the momentum from there. Break your big decisions into smaller ones, and practice taking incremental risks. That could mean investing a little at a time or starting to explore that stock or options strategy you’ve always wondered about.

After all, small steps can add up over time.

See beyond the swings

2022 was one of the most treacherous environments for an investor. And right now, people are terrified that we could find our way back into a bear market again.

Just look at survey data. Investors’ moods soured for most of August as stock prices slid, according to the American Association of Individual Investors’ weekly survey, even though the S&P’s 4.6% selloff was fairly tame by historical standards. And in August, the Consumer Board’s confidence index deteriorated at the fastest pace in two years.

Of course, I don’t want us to fall back into an inflation crisis, or tip the other way into a recession. But why are we afraid of lower prices?

Simple: It’s how you’re wired. Just like your brain warns you when you’re about to touch a hot stove, it’ll tell you to run when stocks fall because it feels like danger is imminent. But in markets, risk is the price you pay for returns. Historically, buying low — and taking risk — has often worked in your favor. Sometimes, you have to override your brain’s natural tendencies to make money.

The lesson: When stocks slide, try cognitive reframing. Sure, your investments may be dropping, but wise investors view pullbacks as stocks on sale instead of times to panic. Why? Because markets go up and down. It’s the natural rhythm of investing. That’s why the S&P 500 has clocked 8% average annual returns since 1950, even after enduring 32 bear markets and corrections.

Even shareholders of Apple — one of the most successful companies in history — have endured 15 selloffs of 20% or more since the company went public 40 years ago. That’s the stomach-churning ride you may have to endure to hold a stock until the market acknowledges your view.

Check your confidence

For some, these wild markets have done a number on our confidence. But for others, 2023 has just emboldened their risk-taking, evidenced by meme stocks and the AI craze.

No matter which camp you fall into, your confidence can tell you a lot about the risks you’re taking. There’s a cognitive phenomenon called the Dunning-Kruger effect, in which your confidence tends to decline as you get more familiar with something. So that blow to your confidence could just be a reminder that you’re learning, like many professionals and investors alike this year.

THE COMPETENCY-CONFIDENCE CURVE

It’s important to keep tabs on your confidence, too. Unnecessary doubt could keep you from reaching your goals, but overconfidence could lead you into risky investments you can’t handle. Market history is littered with people who blew their portfolios up from risky, overleveraged positions. But few people talk about those who missed out on building wealth because they sat on cash for too long.

The lesson: Luckily, there are ways to keep your portfolio in check so your confidence — or lack thereof — doesn’t wreck your portfolio. Set targets for how much of your portfolio you’d like invested in each asset class you hold, and consider rebalancing from time to time by taking money out of one investment and rolling it into another. It’ll help you lock in your gains and keep your risk in check so you don’t let your hubris take over.

Don’t rely too much on market timing and avoid trying to guess what tomorrow holds. Markets can change quickly, and things that work today may not work tomorrow.

Focus on your why

Class, I’ve saved the most important lesson for last.

If you’ve felt unmoored by the ups, downs, and uncertainties of markets, it might be time for an honesty hour. Ask yourself why you’re investing, and don’t be afraid to tap into your hopes and dreams. There’s no wrong answer.

Take it seriously, though. Your “why” is crucially important. All of your investing decisions should flow from your why — from what you’re investing in to how long you should hold each stock and when you’re ready to sell. And if you’re investing just to make money, keep in mind that focusing on turning a profit or beating the market can tie your emotions to your day-to-day returns. Remember, nobody has a crystal ball, so they can’t predict what the future holds.

The lesson: We determine our why to give ourselves tangible goals for our portfolio. Once you have a why, set a goal number — or return, or timeframe — to fulfill that why. And when you have your goal in mind, pick the investments you need to get there, while remembering there’s often a tradeoff between risk and reward. The point is to let the numbers guide you, not your emotions.

If you take the time to establish your why and set your goals, you may find that you don’t have to shoot for the moon to reach your targets.

 

*Data sourced through Bloomberg. Can be made available upon request.