Don’t Let Market Volatility Make You Irrational

By Jeremy S. Office

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During the dot-com bubble of the 1990s, former Federal Reserve Board chairman Alan Greenspan famously coined the term “irrational exuberance.” He was referring to investor enthusiasm that drives asset prices to levels unsupported by companies’ actual revenue, earnings, growth or other key indicators of value.

Greenspan’s catchphrase was a reminder to investors that what goes up must come down. And indeed, there was a historic sell-off from 2000 through 2002, with losses of 49% in the S&P 500. The index fell from a high of 1,527.46 on March 24, 2000, to a low of 776.76 on Oct. 9, 2002.

Both of these events were exacerbated by investors who fell victim to irrational behavior — something I see all the time as an advisor. Unnerved by a decline or seduced by soaring stock prices, investors can deviate dangerously from their financial plans.

Irrational investor behavior

Investors tend to label investments “good” or “bad” based solely on their recent performance. This irrational behavior — buying a “good” stock because the price is up or selling a “bad” stock because the price is way down — can diminish an investor’s returns over time. It ensures that investors will pay too much for successful investments and lock in their losses on others, rather than regaining their money when the market recovers.

Other investors suddenly raise or lower their risk tolerances due to emotion. Changing their exposure to stocks and derailing their plans in this way could mean missing out on market gains during a recovery.

Volatility is a constant

When Greenspan introduced the idea of irrational exuberance, the media plastered the phrase everywhere. But volatility in the markets was and is nothing new. Rather, it’s the one constant. We can’t get all the reward without any risk.

We can assume there will be market growth over the long run so long as there continues to be economic growth, but it will not be linear. Historically, the overall trend of the markets has been up, but there have also been long periods during which the markets have been flat or down.

The real question for investors is, how do you react to these ebbs and flows? It’s easy to let your emotions get in the way of a sound investment strategy.

Removing emotion

You can avoid the whipsaw effects of volatility by staying committed to an investment plan rather than trying to time the market.

This is sometimes easier said than done. Though the media tend to sensationalize market movement, it can still be hard to block out the coverage. Is this market really unsafe? Will my retirement be derailed if I stay in the market? All these questions start churning as the state of the markets gets heavy coverage.

But instead of letting the noise disturb you, dial in to your financial road map. As an investor, do your best to extract emotion from your investing decisions. With the help of a trusted advisor, you can assess market movements’ potential impact on your portfolio and implement a course of action specific to your goals.

Jeremy Office is a financial advisor and the principal of Maclendon Wealth Management in Delray Beach, Florida.

This article also appears on Nasdaq.