Yahoo Finance Taming Investors' Primal Instincts
You've heard of fight or flight, and I know you felt the urge to do one or the other the last time you were truly afraid. But falling victim to this instinct with 401(k) investing could carry long-term consequences.
It's an instinct carried forward through thousands of years of dangerous living. The idea is that humans, when presented with hazard, will choose to fight or run away. Deciding whether to battle or flee is partly determined by the situation, and it's partly a function of individual personality.
However, our ancestors didn't have many intellectual fears--situations that caused fear even though there wasn't a physical risk. In our modern world, we face the intellectual fear of losing money. So even though market drops don't place our bodies in harm's way, we still experience a fight-or-flight urge when our investment holdings take a dip.
When the market loses stability, an investor feeling the instinct to fight may become uncharacteristically aggressive. This fighter could jump into the best-performing funds from the past few weeks or months, giving into the recency bias and not heeding the long-term outlook for the investments. Or he may pour money into a single asset class and ignore the benefits of diversification.
Investors who feel the urge to fight should remember that moving 401(k) plan money to follow returns and/or concentrating on one asset class in an effort to beat a slump is a risky proposition. If anything goes wrong with a fight-based maneuver, losses could be colossal.
Conversely, some investors' instincts shout "cut and run" when the market gets wobbly. The flight crowd is the first to jump to cash when the market loses ground. They run from investing. Then they wait to re-enter the market after it has rebounded. There's a fundamental problem with this behavior: These investors potentially sold investments at a low point then bought investments at a high point; they've set themselves up to lose money in the long term because they've escaped benefiting from the gains inherent to a market recovery.
For new investors, the flight instinct may cause them to miss out on the benefits of compounding. For investors nearing retirement, it may put their nest eggs at risk of being corrupted by inflation.
Experiencing a significant market drop or a full-on recession can have a lasting effect on many investors. People feel regretful for poor decisions--or just for holding steady. The grass is always greener on the other side, and many investors feel they should have done something differently to avoid losses. Further, a greater loss begets more regret, which continues to affect investing decisions for years or decades to come. Leftover fear can trigger more fight-or-flight behavior.
Retirement investors benefit from developing a long-term savings and investing strategy, in part because they can ignore fight-or-flight and stick to that pre-determined plan.
It is comforting to have rational research behind your decisions when you're trying to resist instincts and gut feelings. With a plan in place, you'll have a roadmap when times are tough and your instincts are telling you to fight or flee. Sticking to a strategy can help lessen your fears and calm your instincts.
Create your long-term retirement strategy as soon as possible, if you don't already have one. Then reassess your situation and goals once per year to update your strategy as needed. With a plan and a routine, you put yourself in a better position to make good decisions.
If you're uncomfortable creating a retirement strategy on your own, a retirement adviser should be able to help you establish a plan based on your individual finances, familial situation, risk tolerance, and personal biases. You can then work with your adviser to make rational adjustments as your situation changes and/or the economic climate evolves.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
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