You've just discovered that you're not as brave as you thought. Don't make it worse by acting on your fear.
By the Mole, Money Magazine's undercover financial planner
December 3, 2008: 9:27 AM ET
(Money Magazine) -- When new clients come to me, I ask them a few questions about risk. One is "What would you do if the value of your stocks fell by 50%?"
The vast majority answer that they would buy more stocks. So now that the market has lost about 40% of its value, why are some of these same clients clamoring to sell?
Risk tolerance ebbs and flows. From 2003 to 2007, U.S. stock prices nearly doubled and international shares nearly tripled.
During such good years, you tend to believe that you have a high tolerance for risk. At times like these, your willingness to take chances drops sharply.
Such mood swings can lead you to jump in and out of the market and chase good performance, with devastating results.
According to a 2007 study of investor returns from 1991 to 2004 published in the Journal of Banking & Finance, the average investor pays a 1.5-percentage-point annual penalty for that kind of behavior.
My advice is to never rely on a risk questionnaire to tell you how much you should have in the market.
I ask about risk tolerance only to make the point that hypothetically losing half of your portfolio doesn't inspire the same fear that actually losing it will.
Your investment strategy should instead be based on your goals, your time horizon and what you've saved so far. Success will come from sticking to your plan.
But as you're learning now, buying stocks is emotional. Your investments represent security and freedom. And as you watch your balances decline, you see your dreams fade too. Hence the nervous calls.
What I'm saying is that while I can't make any promises, I wouldn't bet against capitalism over the long run. Chances are, you'll look back and see that this was a buying opportunity.
In times like these, you should push yourself to take more risk than feels comfortable. And in good times, go out on a limb less than you're inclined to.
I'm feeling shock too. But I've bought more stock-index funds. It's scary, but it's also likely the right thing to do