Markets, emotions, and you

Understanding market cycles and your emotions can help you be a better investor.

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Life has its cycles, as do the economy and the financial markets. But when it comes to market cycles, emotions often get in our way. We often do the wrong thing at different phases, buying exuberantly at market highs and selling in a panic at market lows.

Successful investors do the opposite. Warren Buffet says: "Be greedy when others are fearful and fearful when others are greedy."

The economic and market cycles and our emotions

Economic cycles range from 28 months to more than 10 years. Stock market cycles have typically anticipated economic cycles by 6–12 months on average. The cycles are familiar. So are the emotions we feel at different phases, what we want to do versus what we should do.

When markets shift, it's valuable to have a long-term asset allocation plan that can be rebalanced to a target mix of stocks, bonds, and cash. Such a plan can force you to remain disciplined through cycles—so you can buy low and sell high.

The top

All market cycles reach a top. At this point, growth is strong but moderating, unemployment is low, and interest rates are often falling. However, corporate earnings are under pressure, and the risk of a recession is rising. Growth has caused many investors to feel invincible, and many buy more stocks. They buy high—just as the market has crested.

What to consider: Instead of buying, most investors should think about selling some stocks to capture gains, especially if their allocation to stocks has risen above their long-term plan. Buying high-quality bonds might also help prepare for a cyclical drop.

Turning down

After the peak comes the trough. The economy is in recession and corporate profits are sliding. At first, investors hold out hope for the bull market to continue. But as prices fall, anger and regret set in along with the temptation to sell.

What to consider: Now the game is protection and patience. Going to cash can limit your ability to grow your money long term. If your asset mix matches your goals, it could make sense to continue investing.

Hitting bottom

For investors, a market bottom is tumultuous and depressing. Stocks can drop more during this phase. A faint light is at the end of the tunnel as the Fed cuts rates. Even with a solid plan, you may feel defeated. This is a point of maximum pain, and also a point of maximum potential.

What to consider: Perseverance is key. The measured path is to invest and if necessary, rebalance to your target mix of investments—not cash out and lock in losses. Stocks are on sale. Investors who buy in this valley have done well when prices begin rising. Historically, powerful rebounds have followed some of the deepest market drops.

Rebounding

After the bottom comes the cautious enthusiasm of an emerging bull market. The economy shows signs of a rebound, interest rates are low, and corporate profits are rising. So are stocks: The average increase in the S&P 500 the year after the bottom of a market cycle is 47%. But many investors have checked out, and as the market rises, they miss the early, often powerful, rebound.

What to consider: Think like a contrarian. The stock market is rebounding. If you remained invested, you see some recovery. If your stock allocation has gone below plan, it’s time to bring your portfolio back to your long-term target.

Rising again

The bull market is in play, and investors grow confident, even greedy as they sense exhilaration again. The economy is expanding. Stock prices are going up. Many forget their target mix of stocks, bonds, and cash and their portfolio drifts too heavily into stocks.

What to consider: Asset allocation cannot guarantee a profit or avoid a loss, but your target asset mix can hold greed at bay and prepare you for the next downturn. Rebalancing your portfolio now could include selling stocks and buying bonds.

Managing your emotions with a plan

Ask any successful investor their secret and the most common response is to make an investment plan—and stick to it. A strong plan includes a mix of stocks, bonds, and cash that aligns with your goals, time horizon, and your ability to manage risk.

Over time, discipline helps successful investors buy low, sell high, and build wealth. Stay in touch with your emotions and what's driving them—but don't let them get the better of you as an investor!

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