On the day the stock market tumbled nearly 1,000 points in a matter of minutes, Doug Lennick sent the following e-mail to the financial advisers he teaches about behavioral finance:
"This is not a great day for portfolios, but a great day to be talking with your clients and prospects about their emotions and financial decision-making. Remember to help them reflect on the bigger picture and the long term!"
How right he was. A week later, the market has recovered its losses. Investors who panicked and bolted from stocks have been left in the dust. Those of us who stuck it out have had our confidence shaken, and we've been reminded that investing in stocks can be volatile and scary.
"Emotions are what destroy successful investing," said market historian and mutual fund manager Steve Leuthold. "It's what kept you from adding more money a year ago, because you were frightened because of the news. And when everything's rosy, then you feel good. That's the very time you should let some of your disciplines take over from your emotions."
So how can we protect ourselves from ourselves?
Don't join the crowd.
Leuthold said he's bullish about the stock market for several reasons. The economy is recovering he says, and the stock market isn't too expensive. Plus fixed income isn't a haven for investors because yields are low. The contrarian in him likes that "investor pessimism has returned, whether it's Greece, whether it's the oil spill," he said. When contrarians see investors heading toward the exits, that's when they tend to head the other way. Consider herd mentality and whether it presents buying opportunities before joining the stampede.
You'll be going against human nature when you do. In his new book, "Financial Intelligence: How to Make Smart, Values-Based Decisions with Your Money and Your Life," Lennick, writes about how our brain is still wired to flee from danger.
So when a Greek debt crisis strikes fear into the markets, we react as if a saber-toothed tiger is on our tail and we split. Pair that with the fact that technology makes it easier to quickly sell out of stocks, and it's no wonder some investors make rash financial decisions only to think through the consequences after it's too late.
Lennick suggests people need to develop a plan to deal with the certainty of uncertainty. It's impossible to know what the market is going to do or when we're going to die. "Don't predict the future. Plan for it," he said. Be diversified. Make sure you have cash to tap during market downturns, as well as access to inexpensive credit. Buy disability, health and life insurance.
The Dow Jones industrial average has seen triple-digit ups and downs during many recent trading sessions. There's no doubt the market barometer will see similar swings in the future. If you have an itchy trigger finger, memorize Lennick's four "R's."
Recognize: This is when you "hit the pause button," Lennick said, to ask yourself what you're thinking and how you're feeling in the aftermath of a bad market day.
Reflect: Think about your values and what matters most to you. With that in perspective, Lennick argues, you will be more likely to make financial decisions that align with your life goals, not your impulses.
Reframe: This is a concept Lennick describes in his book with the Winnie the Pooh quote: "I was going to change my shirt, but I decided to change my mind instead." When the market drops, instead of thinking, "I'll never retire," take a step back and remind yourself of the plan you have in place. And if you're afraid of losing your standard of living in retirement, think back to your values. How much money do you really need to keep what matters to you most?
Respond: "Sometimes the response is to do nothing," he said. Sometimes, you can take advantage of the opportunities that others created for you when they reacted irrationally. Marcus Winbush, managing partner of Breneman Winbush Wealth Management in Rochester, figures humans will be humans. So the smart investor would be wise to study up.
Winbush also suggests finding an adviser, pointing out that Daniel Kahneman, who shared the 2002 Nobel Prize in economics for his work on behavioral economics, has an adviser to keep him on track. Even Nobel Prize winners are subject to emotional biases that affect investment decisions.
If an adviser is not in the cards, at least consider finding someone to talk investing with before making major decisions.