How investor psychology can ruin retirement

Individual investors are often times faced with difficult decisions in dealing with an entire asset class that is losing value.

Do you take matters into your own hands, react to your emotions or instincts, and thereby possibly throwing off the balance of your portfolio? Or do you simply ride out the volatility with the hope that the future will bring about a more favorable outcome?

I believe that with so many passive investors overexposed to one asset class, whether that is stocks or bonds, many are asking themselves similar questions. Besides, with little knowledge of what to do with the proceeds, or fear of making a misguided mistake, almost every option feels uncomfortable.

In that same vein, the two primary drivers for investor action are fear and greed. To put these two powerful forces into perspective; a sample scenario could include selling a bond fund because of the general fear that "interest rates are rising,” then buying a stock fund due to the greedy perception that "stocks are going up, and I don't own enough of them.”

It's a rat race that will run you around from now until the day you figure out there’s a better way of doing things.

I'm sure many investors will try to tell me this cycle doesn't apply to them, that they buy the lows and sell the highs, or that they have never succumbed to these forces because they are "long-term" investors. However, I know that deep down everyone reading this article has had a brush with the fear and greed cycle, and the anxiety it besets on your decision making ability.

After all, the 2008 financial crisis would not have been so destructive to so many people if it weren't for the rampant greed in the years leading up to it, then the contagion of fear that ultimately overtook nearly every market on the planet.

So how should investors concerned with asset class depreciation within their portfolio handle these corrections or bear markets?

The easiest pattern to make reference to in the current market landscape is the price action in bonds. Bond investors that endured the rate rise in 1994 are familiar with the current level of fear manifesting itself; but those who didn’t, have yet to undergo a setback like the one we have experienced over the last several months.

A 70% rise in the 10-year Treasury note rate is a serious adjustment, and the general sentiment of the market is that it's circling the drain.

Investors hungry for income have gone from eating everything in sight, no matter what the risks or consequences, to holding absolute contempt for anything that presents correlation to interest rates. These investors have even gone so far as to latch on to the perceived lack of volatility in the current equity market, which in my opinion will only end badly for them.

Individual investors or advisers that make proactive changes to their portfolios are usually referred to as "market timers,” a moniker that I can't stand. Mainly because I'm not timing anything, I'm merely listening to what the market is telling me, and then adapting to it under a specific set of rules.

Going back to the example of the interest rates, if you listened to the market, you didn't need to sell bonds outright. All you needed to do was adapt to the changing environment by exchanging "core" bond funds such as the iShares Core Bond ETF

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-0.25%

or the Vanguard Total Bond ETF

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-0.22%

, for floating rate and low duration bond funds such as the PowerShares Senior Loan Portfolio

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+0.16%

or the Pimco 0-5 Yr High Yield Bond ETF

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0.00%

. To stay higher in credit quality, you could have even used a target duration fund such as the Guggenheim BulletShares 2015 Corporate Bond ETF

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-0.09%

.

Knowing the options available would have enabled you to continue receiving many of the benefits that owning fixed income offers, while still controlling the risks. Making dynamic portfolio changes like this are purely aimed at understanding the current risks, then playing defense with your portfolio.

It can all seem so obvious in hindsight, and to a large extent it was, you just had to pay attention to what the market was telling you. A simple solution for investors wanting to navigate the next major correction better than they did this most recent one is to put in some time familiarizing yourself with the tools you have available. Develop a risk management plan, and actually follow through with it.

The fact remains that most families put in more time researching their next flat screen TV purchase than they do investing their life savings and future retirement nest egg. Use every correction as a learning experience to gather knowledge on what the crux of the problem was, and then research ways you could have better adapted to it.

I have spent my entire professional career doing just that, and I feel better equipped to protect capital and exploit opportunities for clients through researching what I could have done better in the past.