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Fear and greed, both powerful drivers within the human psyche, can prove hazardous to your wealth. That is particularly true during times of heightened market volatility like we have seen since the outbreak of the coronavirus pandemic. Fear is a common response to uncertainty, and you may feel the urge to sell everything before you lose even more. Such a strategy will shelter you from further loss but turn the unrealized paper losses you have already seen into guaranteed losses you may never recover. On the other hand, greed might tempt you to buy more financial securities than you should while the price is low, and that strategy might make you rich. It could also leave you eating cat food.
The academic evidence is clear. Your key to building wealth in the financial markets is to select an appropriate asset allocation (the split of your invested wealth between different categories of financial securities, like stocks and bonds) based on your age, goals, and risk tolerance and to diversify your investments within each asset class so that you spread your risk appropriately. Once you have set your asset allocation, you should stick with it until something fundamental changes, like your life expectancy or expected retirement date. Wild market moves are not a reason to change a wise plan you have made. Quite the opposite, such plans are designed to sustain you through times like this.
Next time, we will take up the topic of what to do if you do not already have an investment plan in place.
Dr. Brian Starr is the LCU Senior Vice President for Administration and Economics and Finance Professor in the LCU School of Business