Financial Planning Magazine came out with an article of interest highlighting “why investors need a little pain in their portfolios.” Behavioral finance has consistently shown that investors have a tendency to act predictably irrationally. We learned from the last two stock market downturns since the year 2000 that money has flowed out of stock funds at market lows and into stock funds at market highs. In short, investors have become accustomed to buying high and selling low which the article discovers can be explained by human history. Our human nature pushes us to run away from pain and towards what brings us pleasure. When translated to investing, investors feel pain when stocks start to fall and in turn they retreat from the pain by selling. Conversely, when stocks are on the rise, investors run towards those stocks and buy while they’re high. Investors begin to believe in the wealth-building potential of the latest asset class surge.
But it is up to advisors to continue to steer investors toward making the hard, sometimes painful choices like rebalancing. That means buying more stocks when the market is in a downturn like the beginning of 2009 and selling stocks when markets are at all-time highs like they have been in 2013. Although it might feel painful in the short-term, this consistent and disciplined approach to investing can contribute towards significant long-term pleasure.