Dion Money Management Blog   Money Management for Retirees and Their Families

All of us have goals. Whether we want to be healthier or wealthier, or advance in our careers or our education, we need some way to keep track of our progress. When it comes to our investments, of course, we tend to pay the most attention to that all-important line at the bottom of our brokerage statements. When the markets are down, however, as they have been for much of the year, that monthly review can become an exercise in discouragement. It’s easy to get frustrated. Many of us may be thinking about heading for the safety of cash or bonds. Some of us may even be contemplating selling a primary residence or even putting long-awaited retirement plans on hold while we build up our nest eggs.

In a turbulent market, managing our expectations can be as important as managing our portfolios. By staying focused on our long-term goals and keeping the emotion out of our decision-making, we can avoid making costly and far-reaching mistakes.

It’s important during challenging markets to keep in mind that even the best professional investors in the world don’t always hit their marks. Consider the fact that Warren Buffett, the fabled “Oracle of Omaha” whose stake in Berkshire Hathaway—at $62 billion as of February 11, 2008—makes him the richest person on the planet according to Forbes magazine, trailed the S&P 500 for several years in the early 1970s. As recently as 2003-2005, Berkshire Hathaway shares underperformed when compared against the most widely-followed benchmark of U.S. equities. If Warren Buffett can lag the market, then all of us not only can—but inevitably do, too. In fact, the top professional money managers only beat the S&P 500 around 60 percent of the time.

As we know from the field of behavioral finance, it’s simply human nature for us to feel the pain of portfolio loss more acutely than we experience the joy of a gain. Researchers who have been able to measure these emotional responses with experiments have demonstrated that a pecuniary loss “hurts” about twice as much as the pleasure we derive from a growing bottom line. Behavioral finance has implications for better investing. To avoid losses, we tend to act in irrational ways, such as selling out of a stock or mutual fund during a period of underperformance—often just before the performance begins to improve. Armed with this knowledge, we may be better able to control the emotions that so often lead to poor investment decisions.

The first and most important step toward keeping overall investment performance in perspective is simply to acknowledge that portfolio performance is going to decline occasionally. From 1969 through 2007, for instance, the S&P 500 had an annualized return of 10.5 percent, although it actually lost ground in 9 of those 39 years. Investors who managed to hang on through those down years would have been rewarded with healthy gains over the long term. Selling during those down years would have locked in losses, triggered taxes and transaction fees and could have made it more difficult to recover lost ground later on.

If you manage your own portfolio, then it’s important to be realistic about what you can accomplish while also balancing work and family. Many of us who have underperformed the markets on our own often turn to professional money managers for help, thinking that they’ve got all the answers. But as the example of Warren Buffett above amply demonstrates, even the best investors in the world don’t always get it right. While there’s no doubt that the education and training of a professional can give investors an advantage in building an outperforming portfolio, perhaps one of the most valuable services a professional money manager provides is an emotional distance from our investments that keeps us from making the poorly-thought-out or hasty decisions that may “feel” right but end up costing us dearly down the road.

To paraphrase John Bogle, the founder and CEO of the mutual and exchange-traded fund company Vanguard, there is a difference between speculation and investing. Speculation means placing most or all of your money on a few risky stocks, timing the markets, and playing your hunches. In short, speculation is gambling with your future. Investing, by contrast, means staying diversified, remaining fully invested even when the markets are down, setting long-term goals and formulating a strategy to get there.

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