4 Ways to Cure Emotional Investing

How to keep your cool and stay focused in a turbulent market.

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No one likes to lose money in the markets. Most people understand and accept that investments go down from time to time. But some folks get so emotional that they make rash decisions, which end up costing them money. That's why you need to create a financial plan and stick with it, no matter how the market is acting. Here are four ways to keep your emotions out of investing and stick to your plan:

Let your intellectual side take over. On a day when the markets are calm, make a list of what you would do if the market gained or lost 500 points in one session. Your responses will depend on whether those movements are one-day events or significant shifts in the economy that will affect your investments in the long run. Try to envision a range of scenarios and write your responses on a piece of paper that you can find later. When the market makes a big move and you're feeling jittery, read your responses. The answers written by your intellectual, rational self should calm your emotional side. Do not make any investing decisions when you're feeling emotional. Stay calm and let your rational side win.

[See How Emotional Investing Affects Your Bottom Line.]

Examine the news. A historic news moment might send the markets down because it appears there will be lasting effects on the economy. Other times, the market might take a dip for no apparent reason—it's just a normal bump. Most of the time, your reasons for investing in a mutual fund won't change because of a one-day or short-term event. Your asset allocation should reflect your tolerance for risk, not what may or may not happen with the market. Stick with your plan and make adjustments only when your circumstances change, not every time the market changes.

Hire an advisor. When your investments lose value, it's okay to feel disappointed. But it's not okay to make decisions about your investments when you're feeling scared and nervous. If you can't keep your emotions out of investing and not tinker with your holdings every time something happens, you need to hire a professional investment advisor to monitor your accounts and make changes when needed. Your advisor is not emotional about your money and should provide sound advice, especially when the markets go through rough patches.

[See 5 Investment Themes for 2011.]

Rebalance. Establishing an asset allocation and rebalancing your holdings regularly is one of the keys to successful investing. Rather than tinker with your investments when you're feeling uneasy, set a schedule to adjust your holdings to reflect your risk tolerance. In good times, some people's investments grow consistently for a few years, so they figure they don't need to change anything. That can be dangerous. Some of the winners in your portfolio might throw your asset allocation out of whack every few months, leaving you with too much exposure to a particular stock or sector. My company specializes in mutual funds; we recommend putting no more than 15 percent of your investments in any one fund to avoid having too much exposure to it. When you're comfortable with your allocations and rebalance a few times a year, you'll be able to handle any kind of market and stay calm. Rebalancing on a regular basis forces you to unemotionally take profits from sectors that have already run up and buy more of sectors that are intrinsically sound, but out of favor at that moment.

Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast-to-coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth About Investing (April, 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations and research to stores in The Mutual Fund Store system.