Investing would be easy if we could remove one thing from the equation: ourselves.
Markets go up. Markets go down. Headlines get louder. And suddenly, the long-term investment strategy that seemed perfectly reasonable a few months ago can feel like the wrong decision.
That’s where the psychology of investing comes in.
Understanding how our emotions influence financial decisions can help us recognize common behavioral traps and stay focused on what actually matters: our goals, our timeline, and our long-term plan.
Don’t Follow the Herd
When markets are rising, it’s easy to feel euphoric. Everyone seems to be making money, and it can feel like the market will continue going up forever.
Then the market drops, and that excitement can quickly turn into fear or even depression. Suddenly, everyone seems to be selling and you may feel like you should do the same.
That’s herd behavior: making financial decisions based on what everyone else appears to be doing.
But investing isn’t a popularity contest. Your investment strategy should be based on your individual goals and circumstances, not what the person next to you is doing.
Don’t Let Recency Bias Drive Your Decisions
Another common trap is recency bias, the tendency to assume whatever has happened recently will continue happening.
If the market has performed well for several years, investors may assume the good times will continue indefinitely. If the market has been falling, they may assume things will only get worse.
Neither assumption is necessarily true.
Markets fluctuate, and periods of strong or weak performance don’t tell us exactly what will happen next. Instead of focusing on what the market did yesterday, last month, or last year, focus on what you’re trying to accomplish over the next five, 10, 20 or more years.
Are you trying to pay off your house? Eliminate credit card debt? Save for retirement? Those goals matter far more than the market’s performance on any given day.
Be Careful What You Let Into Your Head
Then there are the headlines.
Financial news is designed to get your attention, and nothing gets attention quite like fear. “Everything is going to be OK” isn’t likely to generate as many clicks as “The Market Is Crashing — What You Need to Know!”
That doesn’t mean you should ignore financial news entirely. It means you should understand what you’re consuming and why it’s being presented to you.
If you make investment decisions every time a scary headline crosses your screen, you’re allowing the news cycle to dictate your financial plan.
Instead, take a step back. Ask yourself whether anything about your long-term goals has actually changed.
Market Pullbacks Are Normal
Market downturns can feel unusual when you’re experiencing them, but they are a normal part of investing.
Historically, a market correction of approximately 5% can occur about once a year, a 10% correction about every two years, and bear markets, when stock prices fall 20% or more from recent highs, tend to occur every three to five years. The exact timing is unpredictable, but the broader lesson is important: market declines are not necessarily a sign that your investment plan has failed.
Being mentally prepared for those fluctuations can make it easier to stay disciplined when they happen.
It can also create opportunities. When markets decline, investments may be available at lower prices. If your financial situation and investment plan allow for it, downturns can be an opportunity to buy rather than panic and sell.
The challenge is being mentally prepared to do that when everyone else is talking about getting out.
Build a Plan That Can Weather the Storm
One of the best ways to avoid making emotional decisions during a downturn is to make sure your financial plan accounts for downturns in the first place.
That means maintaining an emergency fund and avoiding putting 100% of your money into stocks. Having sufficient cash and more conservative investments can give you the flexibility to cover your expenses without being forced to sell investments during a market decline.
Your investment mix should also evolve as you approach retirement. Generally, the closer you get to needing your money, the more important it becomes to consider how much risk you’re taking and how your portfolio is divided between stocks and bonds.
The goal isn’t to eliminate market fluctuations. That’s not realistic.
The goal is to build a financial plan that can withstand them.
Stay Anchored to What Matters
Investing is as much about behavior as it is about numbers.
You can’t control the market. You can’t predict every downturn. And you certainly can’t control tomorrow’s headline.
What you can control is how you respond.
Stay focused on your goals. Keep an appropriate emergency fund. Maintain a diversified investment strategy. Adjust your level of risk as your circumstances change. And remember why you invested in the first place.
When the market gets noisy, your financial plan should provide something more valuable than another prediction: perspective.
That’s what it means to stay anchored.
By Dan Leonard, Portfolio Analyst & Lead Trader