Having a long-term financial plan gives your logic a leg up over your emotions during times of market volatility.
When stock markets are highly volatile, the roller coaster ride can test even the most stoic of investors. But those with a professionally prepared, long-term financial plan may fare better than most do-it-yourself investors.
The emerging science of neuroeconomics, which combines neuroscience with economics and psychology, has made amazing findings about the brain and investing-related emotions using imaging technology. These studies have found that the survival wiring in your brain, which makes you desire reward and avoid risk or pain, has stronger grounding than your logical wiring. Put to the test, your desire to avoid pain – which always outweighs the desire for reward – will usually win over logic.
A financial plan can bolster your logic when your emotions want to take over. Its greatest strength lies right within its construction. Your financial planner developed your plan based on your personal situation, including your goals, your age, your assets and income, your liabilities, and your tolerance for risk. Faced with volatility and the emotional desire to flee the pain of market losses or increase the euphoria of market gains, your financial planner takes you back to the plan: Has anything changed about your personal situation as a result of the market? If not, there’s no reason to change the plan.
That’s not to say that financial plans should be created in a vacuum and then shoved in a drawer to be dusted off in 10, 20 or 30 years when you retire. Your financial planner will review your plan with you at least annually and whenever you face a life-changing event, including the birth of a child, an empty nest, retirement, divorce, illness, disability, or the death of a spouse, parent, or child.
Multiple studies of past market data have shown that the longer you have money invested in the market, the less volatility your portfolio experiences. That’s because time allows the highest highs to offset the lowest lows. On average, the markets have had positive returns in seven out of 10 years for the past 70 years, according to the Financial Planning Association. The longer you are invested in the market, the more up years you accumulate.
Market swings make headlines because they reflect change – one of journalism’s criteria for news making. Daily swings don’t necessarily reflect a trend of any significance. The market can be up hundreds of points one day only to be down the same amount the next day. Trying to guess which way it will go on a given day, week, month or even year is a fool’s game that plays to your emotions.
Financial planning, on the other hand, plays to your logic. As you reach milestones in your life, you can look at your plan and say, “Ah, yes. My planner talked about this, and we prepared for it.” That applies to market volatility as well; your financial planner takes into consideration the effect of market volatility and applies tools such as diversification, asset allocation, and rebalancing, among other strategies, to your investment model. While asset allocation and diversification do not guarantee greater or more consistent returns, they may help offset risk.
Will your account balance at times show a drop in value? Absolutely. No one can guarantee you will never lose money on an investment. A financial plan and the counsel of your financial planner can give your logic the boost it needs to keep your emotions from running roughshod over your financial goals.
Written by Securities America for distribution by Joseph A. Davis, EA, CDFA(R).