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Decision Paralysis. What is it and how to avoid it?
Mind Over Money key principles
Peter Siks
Summary: When there are too many options, sometimes it’s easy to just not do anything, which may lead to losses that it can be hard to recover from.
A constant worry of not timing the market can prevent uneasy investors from reaching their financial goals. Delaying action because of the relentless fear of getting in when the market is too high or selling when the market is too low is what we call decision paralysis.
Decision paralysis is a very common behavioral finance concept. This is what happens to some investors when there are too many choices or too many unanswered questions, and they freeze up and miss out on opportunities.
Trying to time the markets is always an impossible strategy, so here are a few tips to help you reduce risk when market fluctuation is keeping you from investing.
Decision paralysis is a very common behavioral finance concept. This is what happens to some investors when there are too many choices or too many unanswered questions, and they freeze up and miss out on opportunities.
Trying to time the markets is always an impossible strategy, so here are a few tips to help you reduce risk when market fluctuation is keeping you from investing.
Tip 1: Sell some, but not all
The simplest way to reduce risk during market volatility is to 'sit down in cash'. Selling part of your investments, but not all of them, can be an easy button to turn. However, if you sell those assets when the markets are down, you won’t reap the rewards when the markets go back up.
Tip 2: Invest more defensively
Another way to reduce the risk of a portfolio is to opt for more defensive sectors. Don’t choose cyclical sectors – travel industry, automotive and broadcasters, for example – but rather favor less cyclical sectors such as food, utilities and healthcare.Tip 3: Spread your shares more
Another way to reduce risk is to diversify your shares. Don’t choose two or three individual titles in one sector. Invest in multiple asset classes such as bonds and/or commodities. A globally diversified bond ETF can still have a positive return when markets drop. With commodities you can opt for a broadly composed index that includes metals and energy, as well as soft commodities such as grain and coffee.
Finally, it can help to not think too much in black and white terms. If you are now fully invested and you suffer from a fear of timing the market perfectly during volatility, you can of course go partially cash. If the market rises further, you are still in the market with the rest of your portfolio, and in case of a decline, the loss is less than with the full position.
Tip 4: Work with stop loss orders
For the actively managed part of the portfolio, it can be wise to work with stop loss orders. It prevents that 'bleeder' that causes the total return of the portfolio to be cancelled out by one or two wrong choices. And if you opt for the trailing stop loss order, you know that it 'follows' the rise in the share at a fixed distance.Don't think black and white
Making choices now about a future that is uncertain is, and remains, very difficult. Try to remind yourself that you're never going to do it perfectly. If you now 'go full cash' and the stock market continues to rise 10%, then you are disappointed. If you remain fully invested and the stock market falls by 10%, then you are also disappointed. Furthermore, you will never sell at the top and be a buyer at the bottom. So don't expect that from yourself either.Finally, it can help to not think too much in black and white terms. If you are now fully invested and you suffer from a fear of timing the market perfectly during volatility, you can of course go partially cash. If the market rises further, you are still in the market with the rest of your portfolio, and in case of a decline, the loss is less than with the full position.
Conclusion
Decision paralysis happens to the best of us during different situations and life events. What matters is recognizing this conflict in yourself when it happens, and making sure you have a plan of action in place to reference when market volatility makes you uneasy. It is perfectly reasonable to stop and carefully consider what you want to do. Just remember that there are plenty of ways to protect your portfolio as a whole, or individual stocks, from a potential decline.
So, look at your portfolio and give it careful consideration. Especially if you feel that the stock market is (too?) high at the moment. Not intervening is a choice, but let it be a conscious choice.
So, look at your portfolio and give it careful consideration. Especially if you feel that the stock market is (too?) high at the moment. Not intervening is a choice, but let it be a conscious choice.
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