Investors can benefit from mindfulness

When you’re living in the present moment, you’re being “mindful.” And mindfulness can be valuable in many endeavors – including investing.

Recently, we’ve seen an increased interest in mindfulness, although the concept itself is thousands of years old. However, there’s also been some confusion about what being mindful really means. When you’re mindful, you’re keenly aware of your thoughts and feelings, but you don’t act on them – in fact, just the opposite. With mindfulness, your decision-making is based on cognitive skills and a rational perspective, rather than emotions. As such, mindfulness can be useful to you when making investment decisions – because, when investing, emotion is not usually an asset.

Several emotions and emotion-driven tendencies are involved in investing, but two of the most common ones are fear and greed. Let’s see how they can affect investors’ behavior.

When investors are afraid … Investors’ biggest fear is losing money. So, how did many of them respond during the steep market decline from late 2007 through early 2009? They began selling off their stocks and stock-based mutual funds – in fact, U.S. stock fund redemptions hit $27.5 billion in October 2008 alone¹ – and fled for “safer” investments, such as Treasury bills. (In August 2008, before the market crash, about $1.2 trillion in Treasury bills were outstanding; by November 2008, this figure had reached about $2 trillion.²) But mindful investors witnessed the same situation and saw something else: a great buying opportunity. By looking past the fear of losing money, they recognized the chance to buy quality investments at bargain prices. And they were rewarded for their patience, long-term perspective and refusal to let fear govern their decisions, because 10 years after the market bottomed out in March 2009 (as measured by the Dow Jones Industrial Average), it had risen about 300 percent.³

And, as a side note, it’s gone up even further since then.

When investors are greedy … We only have to go back a few years before the 2007-’09 bear market to see a classic example of greed in the investment world. From 1995 to early 2000, investors chased after almost any company that had “dot com” in its name, even companies with no business plans, no assets and, in some cases, no products. Yet, the rising stock prices of these companies led more and more investors to buy shares in them, causing a greed-driven vicious circle – more demand led to higher prices, which led to more demand. But the bubble burst in March 2000, and by October 2002, the technology-dominated Nasdaq stock index had fallen more than 75%⁴. And since some of these companies not only lost value, but went out of business, many investors never recouped their investments.

To avoid the dangers of fear and greed, take these steps:

• Know your investments. Make sure you understand what you’re investing in. When you purchase stocks, know the fundamentals, such as the quality of the product or service, the skill of the management team, the state of the industry, whether the stocks are priced fairly or overvalued, and so on. And be prepared for sharp price movements, especially for those stocks considered to be more aggressive. When you purchase bonds, generally, you might want to look for those classified as investment grade, which are typically considered the least risky. The better informed you are about all your investments, the less likely you’ll be to give in to greed, by chasing after “hot” investments, or fall victim to fear, by bailing out on good ones.
• Maintain the appropriate asset allocation. To help fight against the emotional forces associated with investing, you’ll want to employ as much guidance and structure as possible to your own investment portfolio, which means you’ll want to construct the proper asset allocation – the mix of investments (stocks, bonds, government securities, and so on) that’s appropriate for your age, family situation, goals and risk tolerance.
• Rebalance when necessary. After you’ve established your initial asset allocation, you don’t have to stick with it indefinitely. Changes in your life – new job, new children, new plans – may well affect your ideal asset mix over time. Also, as you get closer to retirement, you may want to move some – but certainly not all – of your growth-oriented investments to more conservative, income-producing ones, to lock in potential gains and to avoid the need to sell the more volatile investments when their price is down. Consequently, it’s a good idea to rebalance your portfolio periodically.
• Keep investing. Ups and downs are normal features of the investment landscape, but they can certainly contribute to anxiety and fear – and, just as importantly, they can lead you to make poor choices, such as not investing for a while. Conversely, by continuing to invest over time, rather than stopping and starting, you can more easily follow a cohesive, long-term investment strategy.

By following these suggestions, you can help yourself take a lot of the emotions out of investing, and, in the process, become a more mindful investor. To learn more about making investment choices that make sense for you, contact an Edward Jones financial advisor.