The Sleep at Night Test

Out of all the people I've talked to, one of the most common things I hear is, "I just can't watch my account go down."

It always comes with a story. Usually it goes back to a stressful stretch in the markets. Maybe it was 2008, maybe the early days of COVID, maybe one of the other downturns along the way. Watching an account drop fast, or get cut nearly in half. Maybe a decision made in the middle of it that still stings. The experience leaves a mark, even for people who stayed the course and recovered financially.

So when someone tells me they can't handle market volatility, I don't argue with them. I start with their why, and with how they actually think about risk.

Education Helps. But It Only Goes So Far.

I'm going to reference a couple of studies here, and I want to be upfront about why. Not to impress you with academic credentials, but because the research makes something clear that I think is actually pretty amazing: this is not a you problem. It's a human problem.

A lot of this traces back to two psychologists, Daniel Kahneman and Amos Tversky, who spent years studying why people make the financial decisions they do. Kahneman won the Nobel Prize in economics for this line of work (Tversky almost certainly would have shared it, but he had passed away by the time it was awarded). One of their central ideas, called prospect theory, describes something they named loss aversion: losses feel roughly twice as painful as equivalent gains feel good. Losing $100 doesn't feel like the mirror image of gaining $100. It feels significantly worse.

Years later, economist Richard Thaler (another Nobel winner) took this further along with a colleague, Shlomo Benartzi. They called it myopic loss aversion. Even investors with long time horizons (people who won't need this money for 20 or 30 years) tend to judge their portfolios through a very short-term lens. And the ironic thing is the more often you check, the more losses you see, because short stretches show red far more often than long ones do. Each of those moments is a reaction to a single day, not to your 25-year trajectory. That short-term reaction is often what leads to decisions people end up regretting over the long run.

And the data backs this up. DALBAR, an independent research firm that has studied investor behavior for decades, consistently finds a gap between what the market returns and what the average investor actually captures. The reason usually isn't that people picked the wrong funds. It's that they sold at the wrong time, sat on the sidelines too long, and missed the recovery. Over long stretches of time (we're talking decades here, not a single year) the average investor has tended to capture less return than the market itself.

But Here's What I Also Want You to Consider

If volatility genuinely keeps you up at night, that matters and needs to be accounted for. A portfolio you can't stay invested in isn't doing its job, no matter what the "expected" return looks like on paper.

At the same time, I'd be doing you a disservice if I didn't say this clearly: avoiding market risk doesn't mean avoiding all risk. It just means you've traded one type of risk for another.

The risk most people don't think about is the quiet one. Inflation. If your money is sitting in cash or very conservative investments, it may feel safe (but it's slowly losing purchasing power). What costs $5,000 today may cost $7,500 or $9,000 in 15 years. If your investments don't keep pace, that gap becomes a real problem.

Then there's longevity risk (the risk of simply living longer than your money lasts). People are living into their 80s and 90s at much higher rates than previous generations. A retirement that starts at 62 or 65 may need to fund 30+ years of expenses. That's a long time to ask a very conservative portfolio to hold up.

I'd rather someone understand that both risks are real, and make a conscious, informed decision about which one they're willing to accept more of, rather than only thinking about one of them.

What a Good Plan Actually Does

The goal isn't to force yourself to be comfortable with something that genuinely scares you. And it's not to ignore the emotional side of investing, either. Those feelings are information about who you are and how you're likely to behave in a down market, and any good plan needs to account for that.

But the goal also isn't to react to every market move with a portfolio change. That's how the behavior gap I mentioned earlier gets created.

The way I think about it is this: a good retirement plan should give you enough structure and clarity that you don't feel the need to react every time the market does something uncomfortable (which will happen a lot during a 30+ year retirement!). It should account for your income needs, your time horizon, your tax situation, and yes, your tolerance for watching the numbers move. It should be built in a way that, when things get bumpy, you can look at the plan and remind yourself (or have your advisor remind you, which is sometimes needed) why you're doing what you're doing.

The sleep at night test is a real test. But it's worth making sure you're passing it for the right reasons (because you have a solid plan you understand and believe in) and not just because you moved to cash and stopped looking.

The Question Worth Sitting With

Before you make any big change to how you're invested, it's worth separating two very different fears. One is the fear of watching your account drop in a rough stretch. The other is the fear of actually running out of money. They feel similar in the moment, but they point to very different decisions.

Here's the test I keep coming back to. A good decision is one you can still defend ten years from now, once you know how the story played out. If you move to something more conservative because you looked at the tradeoffs and made your peace with them, that's a decision you can live with. If you did it in a reaction you'd have a hard time explaining later, that's worth a second look before you pull the trigger.

So before you make a move to sleep better at night, it's worth asking what kind of sleep you're actually buying. The kind that comes from a plan you believe in, or the kind that comes from not looking. One of those holds up over time. The other tends to catch up with people.