Do you make decisions based on evidence or emotion, information or instinct? Many people believe that some just have a knack for choosing good investments. But in reality, successful investing is much more a science than an art. And emotions can really mess up that science, especially when we aren’t even aware of them.
Have you ever been unable to make a decision because you were paralyzed with worry and anxiety about the future? Have you ever wreaked havoc on your budget for the momentary high of acquiring something you really wanted? These are all examples of how we let our emotions rule our daily decisions.
And unlike decisions about what to eat for lunch, what we do with our money can have long-term consequences. For example, you are tempted by the “next greatest investment” that you can only be a part of if you rush to get on board. Or you panic during a market downturn and sell off stocks only to lose when the market eventually rebounds, throwing off your entire retirement plan. Jumping into things or making split-second decisions without the right information is a bit like gambling in Vegas; the payoff could be significant, but so could the loss. A prudent investor will turn away from spur-of-the-moment trends and seek out solid, proven investments with consistent returns. They’ll weigh the risks and make a decision based on evidence.
Many of us claim we aren’t risk-takers, but we define risk incorrectly. We think avoiding risk means avoiding anything we can’t guarantee or can’t control the outcome of. But most proficient investors aren’t afraid to take a risk, they’re reluctant to accept a loss. There is a difference. The first step in establishing how much risk you can handle is by determining what you’re willing to lose. The second step is to always bear in mind the final outcome. If taking a risk could help you retire 5 years sooner, would you take it? What if the loss involved working an extra 10 years before retiring; is it still worth the risk then? By weighing both the potential gain and the potential loss while keeping your final goals in mind, you can more wisely assess what risks you are willing to take with your money.
If only we could know what’s coming. Some investors attempt to predict the future based on the past. And while historical data can give us a framework for the future, we all know that just because a stock rose yesterday, that doesn’t mean it will rise again today. Unfortunately, we may know this in our head, but we often shrug off this knowledge in favor of hunches.
Gut-driven investors tend to pull out of investments the moment they lose money, then invest again once they feel led to do so. While they may do some research, they ultimately act on impulse, possibly leading to huge losses.
Then there are investors who are faithfully saving and letting their investments work for them, but then experience a life event, such as the birth of a baby, marriage, or death, and get a renewed interest in their portfolio. Research shows that people are more likely to ignore long-term consequences when making decisions under stress, so it’s no surprise when they begin to second-guess the effectiveness of their long-term plan and the strategies chosen just for them. The more often they invest in response to short-term needs, the more incoherent their supposed strategy becomes. If the financial changes they make are dramatic, it can lead to financial catastrophe.
It’s not easy to control our emotions, especially when it comes to money. But there are a few tried-and-true ways to use your behavior to help your investments instead of hurting them:
At Point Wealth Management, we want to help you make smart decisions about your money. We believe that knowledge is power and the foundation for wise decision-making. If you are ready to break free of emotional reactions and make sound choices that will help you pursue your goals and avoid costly mistakes, schedule a call and meet me virtually for a no-strings-attached conversation!