Be cool: The other side of risk is opportunity
In investing, riskier investments tend to offer higher potential rewards. But investing is a marathon, not a sprint, and maintaining your investment composure in the face of short-term market turbulence can help you benefit from long-term market trends. In other words, getting comfy with risk can help you reap the rewards.
Stomaching short-term market volatility
It’s important to understand your personal appetite for risk when investing. While investing is helpful in attaining financial freedom, there are certain to be bumps along the way. How you handle these bumps, such as by avoiding unnecessary adjustments to your asset allocation, is often as important as what’s actually in your portfolio.
Investors can sometimes be their own worst enemies in achieving their long-term goals. Psychologists and economists often refer to "behavioral biases" that can influence us to make poor investment decisions.
For example, investors often exhibit "recency bias," the tendency to overly focus on recent, short-term events. Doing so ignores all of the long-term reasons they chose their personalized asset allocation and investment plan in the first place. Furthermore, withdrawing your money when the markets are at their lowest means you may miss out on earning value when markets move up again.
Short-term vs. long-term investing
The chart below shows that, on a daily basis, the stock market is positive 53% of the time and negative 47% of the time, giving you odds only slightly better than a coin flip on any one given day. This means that investors could spend almost half of all days worrying about markets being in the red (negative). We all know investors like this who fret too much about day-to-day market movements.
Chart 1: The percentage of days, months, and years during which the stock market is positive.
Investment gains are more likely over time
However, over months and years, the markets begin to look more attractive. On an annual basis, nearly three out of every four years is positive. Thus, maintaining investment composure and not overreacting to short-term market turbulence, especially on a daily or weekly basis, can help you take advantage of long-term market trends. Because if you panic and sell, the only thing that’s guaranteed is that you won’t get to reap the rewards when those same investments inevitably bounce back and gain new ground.