Pattie's Blog: How to survive and thrive amid economic chaos
People watch the electric stock index display of a securities firm in Tokyo on Wednesday, July 4, 2012. Asian stock markets were boosted by hopes European central bankers will buoy economic growth with new stimulus measures. Japan's Nikkei 225 index rose 0.5 percent to 9,111.66. (AP Photo/Shizuo Kambayashi)
Published Friday, July 6, 2012 7:22AM EDT
Last Updated Friday, July 6, 2012 7:27AM EDT
For investors, the dramatic headlines have been impossible to ignore. Concerns over the European debt crisis are justified and have rattled the markets and central banks around the globe.
Some would say it is similar to a panic attack.
When panic strikes, psychologists will tell you it’s time to take a deep breath and try to relax. The best thing to do is to put worry aside and focus on what is important -- the long term. In the immediate there can be irrational fear and that doesn’t serve anyone well.
The recent market volatility reminds us of the impact of psychology and human behaviour on the market, and the dangers of emotional investing.
Fear and anxiety are very powerful emotions that affect investors in volatile markets. These emotions may cause investors to sell their stocks in a market downturn for a price less than what the investor paid and as a result miss out on portfolio returns when the market rebounds. It can result in investor “selling low” during a decline in the market and buying into the market when it is at its peak.
Risk tolerance is the culprit for this irrational behaviour. To understand risk tolerance means to understand human nature. Just as people tend to dwell on negative events to a greater degree than positive ones, investors are generally twice as sensitive to losses as they are to gains in their investment portfolios. In other words, the pain of losing something is twice as great as the pleasure of acquiring something of equal value.
Investors also tend to respond and act upon short term gains and losses, despite their actual time horizon. For example, investors saving for retirement in 30 years might evaluate their portfolio every three months when they receive a statement. At that time, they assess the performance of the portfolio and rethink their options. The evaluation is a three-month period so they behave as if the planning horizon (originally 30 years) now is also three months.
Advice for times of market volatility
Be patient -- I know this is easier said than done. It is tough with so many headlines associated with the political risk in Europe, the Middle East and the U.S. We are all feeling a little overwhelmed, but try to remember to factor in your time horizon and your tolerance for risk before you decide to respond to those headlines. I do believe we are doing to get through this and yet there will be some losses especially for those holding sovereign debt. The challenge is to contain the losses. Central bankers around the globe are well aware of the situation but it is going to take time.
Buy quality -- I’m going to say this again, and again, and again. Look for blue chip companies, leaders in their industry with strong balance sheets, great brand recognition and a solid management team with a long track record of performing well through difficult market cycles.
Diversify -- Utilize all major sectors, asset classes and geography when building your portfolio. Patient investors with well diversified, good quality portfolios generally manage to recoup temporary paper losses -- and turn them into positive, stable growth over time.
Avoid temptation -- Temptation to sell can be very strong when the markets are falling; try to be disciplined and think long term.
Finally as we muddle through this period of uncertainty, try to make volatility work for you. It really can create some terrific buying opportunities if you can see beyond the headlines.