How Emotions Can Thwart Your Investment Plans
Life experiences fall into three categories: cognitive (thoughts), emotional (feelings) and physical (physiology and actions). Though interconnected, one of these three has a disproportionately larger impact on your decision-making when it comes to finances—emotions. Emotions are volatile and can be stimulated by many triggers, whether it be a new raise, a death in the family, or fluctuating market conditions.
Research suggests that there are six basic emotions that are experienced universally in humans: happiness, sadness, surprise, fear, anger, and disgust—each of which affect your decision-making capacity in a different way. The emotional part of your brain is the oldest part of your brain and is therefore the best established. It’s that part of the brain that spurs you to react quickly to life’s barrage of experiences. When faced with highly stimulating events, this emotional center typically disables the brain’s rational (and much newer and slower) center. The result?—bad financial choices.
If we’re happy, we tend to be overly optimistic and make faster and quicker decisions (which may not be well thought through). If we’re sad, we can become paralyzed and defer decision-making. But fear-based decision making can be the worst! In this emotional state, we conjure up all kinds of “what if” situations that can result in poor financial or investment decisions: “What if, we have a Brexit-like economic situation in the U.S.? What will happen to my investments, retirement plan, and money?” “What if the stock market goes down after a presidential election?” “What if that stock I just bought is the highest it will ever go? And should I sell it now?” “What if the 10-year Treasury never bounces back up?” “What if I don’t get a raise?” “What if my company sells out?”
I personally have experienced the pitfall of making investment planning decisions based on fear. Both my husband and I currently contribute to our individual 401k retirement plans and we do not use a personal financial advisor. Instead, I have managed the purchase and selling of various equities and mutual funds in both of our portfolios over the past 15 years. Any guesses on whose portfolio is outperforming whose? If you guessed that my husband’s 401k offers a better rate of return, you’re spot on! Why? Clearly, I’m handling my husband’s portfolio with more objectivity than I’m handling my own. If I used the same objectivity with my own account, my 401k would probably be a lot more successful.
So how can you prevent your emotions from interfering with your ability to plan and meet your financial goals? Here are a few techniques you can try:
- Do Your Research – whether you’re a DIY’er or are working with a professional financial advisor, get informed and educated before making any decision. This will help you avoid acting on emotions induced by a lively conversation with friends.
- Don’t Try to Time the Market – personally, I’m a big believer in the long-term investing philosophy. Sure, I’ve scored some big winners on a whim, but I’ve also lost big anticipating market movement. One of the most disciplined ways to invest is through dollar-cost averaging, whereby you invest an equal number of dollars at a regular and predetermined interval. This strategy is good during all kinds of market conditions.
- Know and Accept Your Risk Tolerance – if you’re awake in bed, worried and wondering about your investments, that’s a clear sign that you haven’t dug deep enough to determine your risk aversion. Assess what losses you’re willing to accept on the downside and then put systems in place to ensure your losses will never exceed your threshold.
- Buck the Trend - Warren Buffett once said that as an investor it is wise to be “fearful when others are greedy and greedy when others are fearful.” Challenge yourself to rise above your emotions as you process and ponder your decisions logically. And be cautious of making decisions based on trends or on a “herd mentality.”
- Stick to Your Plan – if you don’t have a written plan, make that your priority. Create a plan and stick to it. When faced with a decision, refer to your written plan and exercise discipline, discipline, discipline!
- Hire a Professional Advisor – Ok, so I’m finally getting to the point where I need to follow some of my own advice! A professional advisor not only helps you develop a plan based on their experience and knowledge but they can also help you navigate the emotional squalls so common in investing by offering an objective perspective. I’m looking forward to articulating my dreams and values with a professional advisor, who can provide emotion-free expertise to assist me in meeting my life goals.
Concerned about retirement? Connect with an advisor today.