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Emotional Risks in an Uncertain Economy

In an uncertain economy, the biggest threat to your financial freedom may be you. When the market went through its painful three-year downturn beginning in 2000, many investors decided to run for the exits and then missed out on the solid returns of the next five years. Fear and greed tend to drive markets, and it’s easy to succumb to either of these powerful emotions. The worst thing that you can do is react to what happened in the market today or yesterday. You need a big windshield and a small rearview mirror.

It’s important to take a long-term, disciplined, and consistent approach to investing with an understanding that market volatility is to be expected.

If you know yourself and if you know how you’ve reacted in the past, you’re in a better position to invest in a way that is right for you. Here’s what to do:

  • Understand your risk tolerance. How much risk can you take? Consider your ability to stick with your investment plan without lying awake at night. Your emotional reaction to volatility is much more of a trait (a long-term characteristic) than a state (a temporary response). Though your reaction to volatility may change as you gain investing experience, it’s also related to how you’re wired.

    Free online questionnaires from mutual fund companies and brokerages can help you assess this aspect of your personality. Alternatively, an Australian company, FinaMetrica, offers two Web-based assessments for a fee.

  • The best plans are based on clear and specific goals, so use the help of a fee-only advisor to help develop an investment plan that fits your financial and emotional needs.

  • During times of uncertainty, look at your monthly statements, but don’t check your investments daily and don’t panic. Stick to your plan.

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