By Jonathan Clements, Director of Financial Education, Citi Personal Wealth Management
Our feelings about the stock market are heavily influenced by the investments we already own, a phenomenon known as "anchoring." Many of us also suffer from "recency" bias, the tendency to read too much into short-term market performance. Both these mental mistakes are likely an issue with the Standard & Poor's 500-index up 146 percent since the March 2009 stock-market low, including a 17 percent gain so far this year.
Reaction #1: If we have owned stocks for a while, we may feel pretty pleased with ourselves. But what should we do next? Right now, we might be engaging in a fierce internal debate. On the one hand, we may be extrapolating the market's recent returns, so we're happy to sit tight and maybe even buy more. On the other hand, we might feel like we have made back much of our bear-market losses and we want to sell before share prices plunge again. This is the old "get even, then get out" syndrome.
Reaction #2: If we have been sitting on the market's sidelines, we might be kicking ourselves for not buying stocks earlier. What to do? We might be emboldened by the market's gains and we're now tempted to rush into stocks. Alternatively, we might hate the idea of buying at today's higher prices, so we're waiting for a stock-market relapse before investing.
Needless to say, this maelstrom of emotions isn't especially helpful. Ideally, we should ignore recent market performance and the price we paid for our current investments, and instead dispassionately consider what portfolio makes sense given our individual circumstances.
How can you get yourself to do that? It might be time to schedule an appointment with a financial adviser. But before the meeting, try this thought experiment: Imagine you were talking to your neighbor, who is of a similar age and has a similar financial situation. What investment mix would you suggest to your neighbor? That may be just the sort of portfolio you ought to own.
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