Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.
Our minds take shortcuts to make decisions. When we aren't sure where to order takeout from, we tend to look to online ratings to help us decide. Usually, these shortcuts are for the better: They help us react quickly, and we can manage the thousands of choices we make every day. But sometimes mental shortcuts lead us astray--that's when they become biases.
Because our finances are so complex, many of the shortcuts we use in everyday life can take us down the wrong path when we're thinking about money--even more so when we're unsure, distracted, and anxious, as many of us are today. Right now, it can be natural to fall prey to recency bias and believe that a 10% drop in our portfolio means that it will continue to drop, or to give into herding behavior when markets are volatile, following other investors as they panic and pull their money out.
We can't erase our biases, but we can use tested techniques to prevent them from affecting our decisions. Here's a checklist to help manage market volatility--and the biases that can come with it.
1. Get to know your biases. Research shows that understanding our biases can help us spot them. Take time to read about the psychology behind decisions and emotions. It's not that you personally have "a problem"--we all make poor decisions sometimes, and it's useful to understand the role our biases play in everyday decisions about our lives and money.
2. Turn down the noise. Learning about frequent price changes can put any investor on edge. Set a schedule for how often you check your portfolio. You'll be able to focus on the long-term performance of your investments and progress to your goals--not daily changes. When the markets are volatile, you may consider modifying the schedule but keep it moderate. Make a rule to catch up on the news once a day, or even once a week.
3. Create speed bumps for decisions. Sometimes the only thing we need to make a good decision is time. But it can be tough to slow down when emotions are high. To avoid a hasty decision, try setting up decision-making "speed bumps." A speed bump could be a three-day wait rule where you can't act on a decision for three days. You could also decide that a trusted friend or partner has to sign off on a decision before you take action. These speed bumps can help you take a step back from your emotions and make time to think.
4. Reconnect with your goals. If you feel anxious about your finances, take a break from daily market performance and check in on your goals. Reacquaint yourself with what you're working toward, why you set those goals, and how you plan to reach them. Adopting a long-term focus is never easy, but you can try using the three-step process we developed to slow down and recommit to your goals.
5. Be your own devil's advocate. If you're leaning toward selling an investment, ask yourself why someone else might buy that investment. Our minds have an easier time remembering and noticing facts and ideas that support our opinions. Forcing ourselves to take a different perspective before acting can reveal every angle of a decision. Using this technique can also help when you're sifting through information online. If you keep coming across evidence that supports your opinion, challenge yourself to seek out credible information that convincingly shows the counter opinion.
6. Thoughtfulness matters. It's hard to stay calm and wait out the storm when your portfolio's losing value--we have a tendency toward action. Don't suppress that urge; redirect your efforts. Opportunity can abound during market volatility, and this can be a chance to rebalance your portfolio. When stocks are down and bonds are up, you can maintain your asset allocation by selling high and buying low. You can also increase your savings rate to take advantage of market weaknesses or capitalize on lower interest rates.
Although this checklist was made with the recent volatility in mind, these techniques can be helpful in any market climate.