Daily Gains Letter

Three Ways to Prevent Irrationality from Entering Your Portfolio

By for Daily Gains Letter |

Three Ways to Prevent IrrationalityThere’s always something investors are worried about. Recently, we heard about the U.S. government reaching the debt limit, shutting down, and inching close to defaulting on its debt. Investors reacted, and the key stock indices started to slide lower due to concern over what could happen.

Now, with a deal being struck to extend the debt ceiling and budget deadlines, those worries are over, meaning U.S. creditors will get their interest payments and the government will go on operating as usual.

This all brings one very critical question to mind: how can investors save their portfolio from situations like these?

In situations where investors are unsure about what will happen to their portfolio, they can follow these three simple investment strategies. These strategies can help investors not only rationally decide on what to do with their portfolio; but they may even find an investment opportunity as a result.

1. Assess the Situation

Take the recent debt ceiling issue, for example. There were concerns that Congress wouldn’t come to a consensus and the U.S. government would have to tell its creditors that they can’t pay them, causing bond prices to decline and portfolios heavy on bonds to suffer massive losses. But what a lot of investors forgot was that the U.S. economy has gone through similar acts many times before, having passed the debt ceiling 78 times.

The lesson here is that investors need to see whether or not the event/situation they are worried about is going to affect their portfolio in the long run. If it doesn’t—and historically, it hasn’t made much of an impact—they should just wait and see what happens before making any adjustments to their portfolio.

2. Change Weight

The idea of asset allocation in a portfolio is that if one asset class performs poorly, the hope is that others will do alright. For example, in 2008 and 2009, stocks were horrible for the portfolio, but on the other hand, bonds weren’t as bad.

The lesson here is that instead of panicking and losing sleep, investors can sometimes just change the weights of the assets in their portfolio by moving to investments that are neutral to the event or have a very small correlation.

3. Sell, Don’t Wait

The market sometimes moves against investors’ perception and new trends are formed. If an investor is holding an investment in their portfolio that’s developing a trend that they don’t want, the best idea would be to sell the position. It’s better to take a small loss than a substantial one.

The lesson here that investors have to keep in mind is that if a portfolio’s value goes down by 20%, it will have to increase by 25% for them to just break even. The bigger the losses, the higher the percentage gain needed to recover.

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