One of the most important things to consider when investing is the question of when you’ll need the money. If you expect to need it in the next couple of years, you should be investing far differently than if you don’t need to tap it until twenty years from now.
If you have a long time horizon and are invested in hundreds of companies from all over the world, the odds of losing your capital investment is extremely low. With ample diversification, risk becomes (in part) a function of time. If all of your hundreds of companies go bankrupt, the world is pretty messed up. Frankly, your retirement plan will be the least of your worries.
We all know that financial markets go up and down, yet most of us still allow short-term fluctuations to cause us worry. Here are a few reasons why:
1. You’re not confident in your investment process.
If your portfolio is based on a thoughtful and disciplined approach, it will be much easier to stick to your long-term plan when things get scary. A valid strategy should be supported by academic research as well as empirical evidence. You must have confidence in your plan and your process. If you don’t, you will be easily swayed by current events to add risk (or remove risk) at precisely the wrong time.
2. You’re watching too much news.
Counteracting this one is simple, but far from easy. Just turn it off. If you are feeling tempted to deviate from your investment strategy, go on a media fast for one week. See how much better you’ll feel in that short period of time by avoiding the talking heads. Remember, they can’t predict the future any better than you can.
3. You’re listening to people with short-term time frames.
This one can be sensitive. These are your friends, colleagues, and neighbors. It could even be a family member. The best way to fight this battle is to get educated (not so you can win arguments—that is pointless). The reason to educate yourself is to strengthen the confidence you have in your investment strategy. Remind yourself why investing with a long-term focus offers the highest probability of achieving your financial goals. Talk to your financial advisor and share your concerns. If he or she is worth their salt, they will take you back to your Investment Policy Statement and explain why your strategic asset allocation targets are still prudent.
4. You’re projecting the recent past into the future.
This is classic human behavior. By habit, we look for patterns and trends. This can lead to bad decision-making when it comes to investing. In the late 1990s, money poured into technology stocks even when growth rates were clearly unsustainable. After the “.com” crash, people became convinced that real estate was the only safe investment (until that also crashed). During the financial crisis of 2008, many decided to sell stocks at or near the bottom (and missed the subsequent recovery). Currently, the media would have us believe that the problems in Europe are unsolvable. This is the truth: Financial markets move in cycles influenced by fear and greed. The length of each cycle is unpredictable, but things will change. Don’t base long-term investment decisions on the recent past.
5. You’re convinced that the world is headed down a rat hole.
If you truly believe this, move to Montana and learn how to fish. That’s really the only answer for someone who has no faith in the future. Relax. There have always been wars and disease. There have been times of prosperity and famine. In spite of every calamity that has ever occurred, we have found a way to survive and thrive. As long as you believe that capitalism and democracy will not fall apart any time soon, you should have no problem investing in a broadly diversified portfolio of stocks, bonds, real estate, and cash.
Your financial plan, investment strategy, and investment time horizon are your own. Do not let anyone convince you otherwise. Remember this and you will most likely enjoy a comfortable retirement (and sleep much better tonight).
(Adapted from a 7/17/12 article in the New York Times written by Carl Richards.)