Balancing your inner bull and bear

Source: MARKETWATCH

Commentary: Uncertain where the market will go next? Consider this

By Chuck Jaffe, MarketWatch

Last Update: 12:12 PM ET Mar 8, 2013

With the stock market at all-time highs, investors are in the classic situation of having an angel on one shoulder and a devil on the other.

The problem is that most investors cant tell who is who, which emotion is wearing the wings versus the horns.

On one shoulder, there is greed. The market is at a high and depending on who you talk to may be poised to go higher. Doubters who never believed that the markets rally was strong now have no choice but to acknowledge that it has recovered all ground previously lost, and then some. For someone who has been out of the market or at least holding back theres the desire not to miss out, an emotion that is encouraging full-speed ahead.

On the other shoulder, there is fear, the idea that once the market peaks, it is likely to go down. Thats particularly true right now, when the market has climbed a wall of worry and scary headlines, with plenty of experts saying that the market was overdue for a blow-off if not something much more severe even as it approached records.

Both of these messengers are whispering to you, one side calling this a bull market, the other a bear trap; one humming, Happy days are here again, while the other cautions, Happy days are over.

In the middle, theres your head, trying to wrap itself around whats happening and what to do.

Heres the secret: The fact that the Dow Jones Industrial Average reached new highs this week is, comparatively, unimportant. It matters to the market, but unless your financial goals hang in until the market reaches a new peak at which point you could cash out, never invest again and live happily ever after its not that big a deal to any individual. (Before you start screaming, it would be the same if the index hit a 10-year low.)

For todays investors to reach their financial goals, the market is going to have to go a lot higher than it is today, and even if all it does is 4% a year, on average, it will be twice this high before two decades have passed.

All that matters is what happens next, and what you intend to do about it.

As noted by Terrance Odean, a professor at the University of California at Berkeley: Much of [investors] focus and regret is on what has happened and what they wish theyd done differently.

While fear and greed are at opposite ends of the emotional spectrum in investing, they are not quite such polar opposites when it comes to psychology. What makes them more similar, according to experts in behavioral finance, is that each emotion is accompanied by anxiety and worry, sometimes to the extreme. Those concerns make people want to act.

At a time when the peaking market makes people want to act, experts in behavioral finance say the best way to calm the two voices in your ear is to step away from the market, at least for long enough to size up your situation and to get ahold of your emotions.

You should step away from your emotions and assess them from some distance, just as you count to 10 when youre angry, before you speak, says Meir Statman, a finance professor at Santa Clara University. Stepping away, youll note that it is common to be hopeful a preferred term over greedy after stock market ups, and fearful after stock market downs. Youll note that the fear induced by the crash of 2008 lasted long after the stock market recovered almost all its 2008-09 losses. Youll note that what you really fear is the regret youll feel if you buy now and find later that youve bought at the top.

Dont jump into stocks with all your money, he adds. Regret will kill you if the market goes down. Dont stay on the sidelines with all your money in a money-market fund; regret will kill you if the market goes up. Instead, step into the market gingerly with dollar-cost-averaging, the great regret mitigator.

Whether its taking Statmans plan or someone elses, the idea is to have a plan.

Charles Rotblut, editor of AAII Journal, published by the American Association of Individual Investors, notes that the way to ignore the voices is to set your own tone in an investing plan.

One of the biggest mistake investors make is focusing on the short-term movement of the market without having a mechanism in place to prevent their emotions from influencing investment decisions, Rotblut says. Write down how many years it will be before you need the money and then, based on this information, write down an appropriate allocation. Whenever you get nervous, look at the allocation and ask yourself, Is my portfolio allocation still close this ideal or do I need to alter it?

Richard Geist, head of the Congress on the Psychology of Investing, had a plan as part of his means for beating the voices too.

There are three ways to avoid letting [either] side win out, Geist says. One, invest alongside a like-minded other who can help keep your irrational side in check. Two, have a personal plan for your investments, such as some speculative investments that you may sell if the market reaches an all-time high but keep your long-term investments knowing the market goes up two-thirds of the time. Three, try to forget about fear and greed, and focus instead on understanding your companies or mutual fund managers.

In short, if you cant tell where the market is headed and a lot of investors, both greedy and fearful, have missed out as the market was reaching its new high focus more in your investments and what they will do, no matter which way the Dow goes next or how big the move looks. Prep for what could happen and how you would react, rather than trying to guess at whats next and hoping to get lucky.

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