Take Emotions Out of Your Investment Decisions
~ By Herb White, MBA, CFP ~
Investing in the markets, like many other important decisions you make, requires you to take action based both on research and on dispassionate common sense rather than on your emotions. Common sense decisions come from thinking through the potential long-term consequences before acting. Your emotions, including fear, excitement and over-confidence, on the other hand, can lead to costly consequences as an investor. It is helpful for any investor to understand his or her motivations and behaviors as they apply to investing.
Here is an example. Important changes in our lives, such as ushering in a new U.S. president, can be a time of concern, worry and questioning for investors: In this case, what will happen to the economy? What course will the markets take? What will become of my portfolio down the road? Should I worry? Should I sell? These concerns can lead some investors to make unwise decisions regarding their investments unless they are disciplined to use critical thinking—without getting their emotions involved.
Of course, it doesn’t take a national election to cause investors to worry. Negative events and worrisome news are ongoing in life—but when emotions cause you to second guess your own investment strategies, selling or buying due to nervousness about the economy, for instance, you are exhibiting a behavior of investors that behavioral psychologists call risk aversion. This outlook may cause you to hold on to a stock longer than you should, hoping that it will bounce back, or sometimes to sell winning stocks too soon.
Another behavior that psychologists have noted is investor over-confidence—that is, overestimating one’s own investing knowledge and skills. This can cause him to overload his portfolio with investments in a particular geographic region or sector because, for instance, he is simply familiar with it. The consequences of over-confidence can be that the investor trades more actively than is in his best interest.
Do any of these comments made during times of uncertainty in the markets sound like you?
1. “I am so worried right now, I am not going to even look at my investments! That will only make me more nervous and I’ll probably do something I don’t want to do.” (Fear of regret/risk aversion)
2. “I’m not worried! I figure this is a good time to buy, and I have complete trust in my own abilities to pick good investments.” (Over-confidence)
3. “I am an optimist with my portfolio. I know it’s fine and doesn’t need me to over-analyze it. Just hold ’em!” (Over-confidence)
4. “Here we go again another downturn in the markets. This time I am just going to hold on to my investments, no matter how poorly they are doing.” This investor’s attitude describes a fancy term for what a lot of investors do: anchoring. This occurs when they mentally “anchor” their long-term expectations, in their minds, to “that one time” when, for example, the markets had poor performance, so they expect more of the same. This behavior keeps them from moving on, often holding on to investments when they should sell. (Anchoring)
All of these investors are exhibiting thoughts and actions about investing based on emotions rather than common sense. But, while we cannot control the markets, the new policies of the administration, or the weather, it’s good to know we can control our outlook and worry quotient about our money—and avoid these types of blunders in the markets.
Which type of investor are you? Be sure to have a plan of action to remain disciplined and resist these common mistakes. Ask your financial advisor for strategic input on a fully integrated financial plan.
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Provided by courtesy of Herb White, MBA, CFP©, a CERTIFIED FINANCIAL PLANNER™ with Life Certain Wealth Strategies, 8400 E Prentice Ave, #715 Greenwood Village, Colorado, www.lifecertain.com, (303) 793-3999. Securities and investment advisory services offered through Woodbury Financial Services, Inc. Member FINRA, SIPC and Registered Investment Advisor. Life Certain Wealth Strategies and Woodbury Financial Services are not affiliated entities.