Here's the scene: You just opened your retirement account first-quarter statement and one of the stock funds has a big gain (this is a hypothetical scene). As a result, your account balance is up quite a bit. How do you feel? According to Jason Zweig, author of "Your Money & Your Brain," you probably feel euphoric. Pretty powerful stuff those investment gains!

Give me more

Perhaps it should come as no surprise then, that it can be difficult for some of us not to chase performance. Especially after suffering through the recent recession, potential gains are hard to resist. That stock fund that had a big gain - we want more. We might transfer money out of a so-called "clunker" stock into what we think is the "big winner" stock. Out the window goes our long-term strategy, risk tolerance and asset allocation.

Cash for clunkers

Now it's July and you rip open your second-quarter statement, expecting more gains from owning even more of the "big winner" stock. BUT, instead, you have a loss - you think that stock fund is now a "clunker." Now you're probably not feeling so great. Scientists say financial losses are processed in the same areas of the brain that respond to mortal danger. In a response to fright, some people may take all their money out of stock funds and stick it in a money market or stable value fund, hoping it will be "safe."

Potential lower returns

Chasing performance - choosing investments based only on their recent results is spurred on by our fear and greed. It may lead to buying high and selling low - just the opposite of the adage to buy low and sell high. All our back and forth and up and down can potentially lead to lower returns. A recent Morningstar study revealed that over the past decade, the 10-year average fund investor return is 1.68%, compared with a 10-year average total fund return of 3.18%.

Get a grip

So how do we get a grip on our emotions and take them out of our investing decisions? Here are some suggestions to consider:

  • Know how much you need to save for retirement, when you'll need it and your risk tolerance. Develop an asset allocation based on your needs. (Need help? Check out the Asset Allocation Profiler.)
  • Rebalance at the same time each year rather than rebalancing by responding to market ups and downs. If your plan offers it, consider automatic rebalancing. (Look under "Manage My Investments.")
  • Consider a target date fund (if your plan offers them). These funds are already diversified, and the allocations are managed by professional investment managers.
  • Sleep on it. Rather than make an emotional decision you may later regret, sleep on it and that fear or greed may snooze away.

Remember, history tells us that it's time in the market, not timing the market that helps us reach our goals.

Sources:

"Can You Outsmart the Market," Pat Regnier, Money Magazine, January/February 2010, pgs. 86-91.

Morningstar, www.morningstar.com, "Bad Timing Eats Away at Investor Returns," Russel Kinnel, February 15, 2010.

Your Money & Your Brain, Jason Zweig

This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than original cost. Past performance is no guarantee of future results.
Diversification does not assure a profit nor does it protect against loss of principal. Diversification among investment options and asset classes may help to reduce overall volatility.