Rapid City financial advisor Rick Kahler on the risk of anchoring investment expectations to a market high
Imagine that you have placed your retirement funds in a diversified portfolio which includes a portion in the stock market. A year after your initial investment, the news is buzzing with stories about record-breaking market highs. Seeing the value of your portfolio climbing, you feel like a financial genius. Life is good! You feel light, happy, and free from anxiety. You start to envision purchasing a yacht in retirement and sailing into the sunset.
Then eventually, as it did this September, the market takes a nosedive. Suddenly, those feelings of happiness and lightness are a distant dream. Panic creeps in. You’re anxious, afraid that you have “lost money,” and starting to worry whether you’ll have anything left to support your retirement.
Welcome to the world of anchoring, where your serenity takes a back seat to anxiety.
Anchoring is a quirk of human psychology, a cognitive bias where we fixate on a specific reference point when making decisions. This is often an initial piece of information, or it may be a noteworthy point like a recent market high. We might rely on that number as our definition of investment success. Any downward deviation from that point feels like an emotional gut punch that may lead to fear, panic, or even despair.
In reality, often we are not really losing money or suffering negative returns. Yet even if our portfolio still shows positive returns, what we focus on is that it’s not as high as it once was. We feel as if we are losing money, no matter how relatively small that “loss” is.
Anxious investors, anchored to that previous market high, might make impulsive decisions like selling part or even all of their portfolios at a loss. It’s an attempt to regain a sense of control and calm the anxiety. It's an overreaction, much like a passenger on a cruise ship seeing a whitecap, feeling the ship roll, and running for the lifeboats.
One aspect of investing in stocks, bonds, and real estate is that market fluctuations are common. They happen a lot. Even if a downturn feels like the end of your investing dreams, seen from a long-term perspective, it is not.
A long-term perspective helps you understand that market dips are like those whitecaps on the ocean. They may be annoying or even frightening, but they are not enough to sink an ocean liner. Over time, markets tend to trend upwards, despite periodic setbacks. Diversification helps you balance the risk by spreading your investments across different asset classes. A portfolio of stocks, bonds, real estate, commodities, and cash equivalents will rarely sink, and will typically do better in the long term than putting all your money in the bank.
How can you avoid falling into the anchoring trap? Try reminding the parts of yourself wanting to jump overboard that, historically, any downturn in markets is eventually viewed as a blip. It may not feel like that now, but in hindsight you will recognize it as such. You may want to do an Internet search on historical data that shows the market’s long-term pattern of riding out tumultuous storms.
If that is not enough, consider talking with a financial advisor or financial therapist. They can help bring perspective to your fears, validating those that are true and helping you modify those that are not.
Anchoring to recent market highs and getting caught in an emotional storm of short-term anxiety is common. Holding to a long-term perspective that focuses on the horizon can help you ride out that storm and regain your balance. Then, instead of abandoning ship, you can continue your investing journey and look forward to smoother sailing.
Rick Kahler, CFP, is a fee-only financial planner and financial therapist with a nationwide practice, Kahler Financial Group, based in Rapid City. His co-authored books include Coupleship Inc. and The Financial Wisdom of Ebenezer Scrooge.
