Breaking Free From Emotionally Driven Investment Decisions
There is a vast difference between a person who buries his head in the sand, refusing to recognize the chaos around him, and the person who hears the clamor but determinedly forges ahead, unwavering. Unfortunately, when it comes to investing, onlookers often confuse the two, especially during peak times of emotional investing, –which is what we’re going to take a look at today.
Three Reactions to Real or Imagined Chaos
Think about it for a minute. Whenever the market is taking one of its roller coaster rides and the news headlines are blasting us with predictions of gloom, doom, and financial chaos, what happens? Generally, investor reactions can be broken down into three categories:
Reaction #1: The Emotionally Driven Investor
The emotionally driven investor is quick to second guess his plan or the decisions he made yesterday. This is the person who hears the news and feels he has to “do something ” to control, contribute, or fix the situation. Instead of being certain of his plan and staying on course, the emotional investor can’t seem to be able to control his urge to follow the crowd. He will often pull in and out of markets at the wrong time, further adding to his frustration, and ultimately costing him financially.
Reaction #2: The Head in the Sand, Hope for the Best Investor
There are some who don’t have the problem of getting in and out of markets or making emotionally charged, fearful decisions, but that doesn’t mean this group is stress-free and confident. The “head in the sand” group often worries if they are doing the right thing with their nest egg. Maybe they have their money in the company 401(k) plan and make regular contributions, but really don’t know whether they are doing what’s best for their family or not. This person takes comfort in the fact that they are doing something, although they often steer clear of investment articles, news, and personal finance books, because they think it’s all too confusing for them. So, an easier solution? Just keep making those weekly contributions and hope it will all work out when retirement rolls around.
Reaction #3: The Unwavering Few
The third group, the unwavering, keeps up with current events, the economy, and understands the fact that the market goes through cycles and times that are more volatile than others, but they have the confidence and peace of mind that markets consistently perform over time. They aren’t looking for the latest investment ‘sure thing’ and they don’t seem overly interested in the track records or predictions of the currently spotlighted gurus.
Why? What’s the difference between the wavering and the unwavering, or the fearful, anxious planner and the confident? The real reason is much deeper than simple willpower.
The Real Reason Behind Emotional Investing
Let’s face it, no one sets out to be an emotional investor. That’s not the plan. No one says, “Hey, I’m going to determine my risk tolerance, decide on an investment strategy, put a large portion of my earnings in this, and then at the first sign of chaos, I’m going to bail out.” Then why do we react the way that we do?
The real key which separates the emotionally reactive investor from the one who can calmly continue to move forward lies in two things knowledge and a plan.
The emotional investor either doesn’t truly have a plan, or he isn’t fully persuaded his plan will work. This absence of confidence in what he has decided on, can be due to lack of experience (he’s never seen it work for him in the past) or lack of knowledge (he’s unsure of his plan, or is simply relying on the assuring words of his financial advisor who is filling his portfolio with products he doesn’t understand).
Do you want the solution to emotionally driven decisions? Great. I’ve got it for you, and it’s much simpler than you think.
The Dynamic Duo – Knowledge and a Plan
The main reason investors make emotionally charged decisions is simply because they don’t have a strong, internal belief that they are doing the right thing. When you don’t have that peace of mind, you are at the mercy of reacting to what you see. You “see” the market taking a tumble in a certain sector, so you “react” by pulling out of that market. But, what did you just do? You sold low when the market was falling, which is exactly the opposite of what we are supposed to be doing. Why did this happen? Why do we deviate from our original plan? A lot of experts say that’s the way we are wired, — to be reactive, but I think it’s a much deeper problem than that. I believe investors make emotionally charged decisions because they know, deep down that they don’t actually have a plan they can believe in.
The solution? Knowledge (know what your plan consists of) and reassess whether your plan is right for you.
Getting in and out of the market, trying to time the market, and looking to gurus who can predict the future of certain investments, — these are all the sign of a deeper problem. Maybe you don’t actually believe in or have knowledge of the way markets work, so you haven’t laid a foundation of prudent investment strategies. Learning about the market is going to take some time, and may take some undoing of information your financial salesperson has filled you with. Start with the basics. Our new book, 401(k) Conspiracy can help you look at your investment strategies in a new (and rational) light.
Your main focus shouldn’t be on the state of the economy or picking winning stocks. Your main focus should be on reducing cost (cutting out excessive management fees, commissions and bonuses paid to your financial advisor, and hidden fees wrapped up in your mutual funds) and minimizing risk (by diversifying your portfolio with sectors that don’t track together and constantly rebalancing so you are buying low and selling high).
It’s having a prudent plan that separates the “head in the sand” investors from those who truly have peace of mind. With costs at a minimum and a well balanced portfolio, the unwavering investor doesn’t have to hold himself back from throwing in the towel when certain markets fall. With the proper plan in place, timing the market isn’t necessary since you are working with it, not against it.
If instead of peace of mind, you have that gnawing feeling that things just aren’t right with your financial plan, your fears are probably not unfounded. Whether you are the anxiety filled “head in the sand” investor or the emotionally driven market hopper, make the decision today to accomplish two things:
- Gain the necessary knowledge to properly assess your current investment strategy
- Make the adjustments to your investment strategy so you can have peace of mind (and a plan that you can believe will perform over time)
A plan, knowledge of exactly how that plan is designed to perform, and a belief in that plan are the first steps to investment success and the ability to break free from emotionally driven decisions. Are you ready to make that change?
Bryan Binkholder, The Financial Coach, is a catalyst for change in the financial industry, exposing misleading information and clearing away the smokescreen that the industry likes to put out there. With a true passion to make a difference, Bryan offers practical insights on financial topics, investment strategies, and business success. A registered investment advisor and motivational speaker, Bryan is best known for exposing the inner workings of Wall Street and bringing clarity to common investment misconceptions. Be sure to take advantage of his two most popular resources: 7 Deadly Traps of Investing and The Six Pitfalls of Retirement Planning.