By Nina Azwoir, First Vice President, Investments
Emotions help us in so many aspects of our lives – from deciding which color we want to paint our homes to what to cook for a large family dinner, we unknowingly use emotions to fuel decisions that we make. Oftentimes, our emotions help to intuitively guide us when logical reasoning doesn’t readily present itself, however, in some situations, like investing, emotions can lead to more harm than good. Leaving your emotions at the door when investing your money saves you from making costly mistakes and can help keep you on track with your long-term goals.
Understanding how emotions influence our decisions and judgements when doing something as significant as investing can go a long way in ensuring that you keep a level-head when managing your money. Humans tend to respond emotionally in decisions when faced with uncertainty, a phenomenon known as Psychological bias, that can result in errors of judgement.
For example, emotions can lead you to take on more risks to prevent a sure loss, but when faced with a sure gain, we fail to take risks to maximize our profits.
The fact of the matter is that the more emotional an event happens to be, the less sensibly we respond. So, how can we prevent our emotions from clouding our judgements, and what alternative strategies should we utilize to ensure that the investments we make to guarantee future stability are well-reasoned and logically sound? Well, first, we need to look into the common emotional mistakes that people make when investing.
Understanding Emotional Investment Mistakes
There are four main emotions that can impact how you invest your money but being able to recognize and combat them will prevent you from making common investment mistakes.
1) Impatience, which causes frequent trading to try and quickly enhance returns, can lead to higher trading costs, more taxes, and lower returns in the long run. To avoid falling victim to wanting to see results quickly, building and following an investment plan can stop you from getting distracted by short-term movement of the market and remain on-track with long term goals.
2) Overconfidence, like relying on “hot” investments to boost your portfolio’s performance, can lead to lower performance and a higher risk of loss. Instead of following word-of-mouth, select investments based on research, not, and keep your portfolio diversified to generate more consistent returns in any market.
3) Another common emotion that can affect your investment decisions is fear. Fear of loss can result in becoming too hesitant to reenter the equity market, which in turn can prevent you from losing income by failing to capitalize on a market rebound. Rather than allowing fear to hold you back, try looking into easing into the equity market with an automatic investing strategy like dollar cost averaging. Fear and its byproduct, indecision, make you more likely to stay in cash to help protect your assets from market volatility. However, cash alone is unlikely to generate the returns necessary to achieve your retirement goals. Overall, this can lead to a loss of purchasing power over time. Monitoring your portfolio using the “3 Bucket Model” to review your asset allocation can help to offset the fears that inherently come with taking financial risks.
4) The final primary emotion that can impact how you choose to invest is panic. Say for example, one of your investments isn’t doing too well. If you allow panic to control your decisions, you may think selling equities in down markets and moving to cash may help, but this only ensures short-term safety. Doing this leads to potential shortfalls in retirement income and can prevent you keeping the long-term growth necessary to reach your retirement goals. Instead of letting panic guide you, try staying calm and using history as a reliable tool to guide you in maintaining your long-term focus.
Managing Emotions and a Trusted Advisor
It may seem overwhelming to try and keep all the various emotions listed above in check, but there are simple ways that you can manage your emotions when investing in order to help you yield the most effective returns.
First, make sure you understand how your investments will respond to different market conditions. Focusing on the key benefits and the potential pitfalls, such as how your investment is likely to perform in turbulent markets, will make you less likely to make emotional mistakes because you’ll be able to understand the nature of the risks you take. Remember to always keep in mind that the more volatile your investment, the stronger emotions you may feel when dealing with them.
Another way to prevent your emotions from disrupting your long-term investment plans is to focus on strategizing rather than reacting . Building a diversified portfolio can not only generate consistent returns but can also offer a sense of stability when dealing with strong emotions.
Creating a withdrawal strategy can also give you the reassurance that your income will last for life.
Finally, seeking an outside perspective, like a trusted financial professional that suits your needs and availability, can help you navigate the ups and downs of the market. A financial professional’s third-party objectivity and their ability to help guide you during difficult decisions reduces your risk of making emotional-fueled investment mistakes.
As humans, emotions are an invaluable tool we use when navigating through life, but when it comes to the world of investments, acknowledging, but not acting on them is your smartest and safest plan of action.
Wintrust Wealth Management
Nina Azwoir
First Vice President, Investment
239-687-5204
3401 Tamiami Trail North
Naples, FL