How to Avoid Emotional Investing
November 14, 2023
How to Avoid Emotional Investing
November 14, 2023
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Money is personal—there’s no denying that. You’ve worked hard for it, and it touches nearly every aspect of your life. In the same vein, emotions are ever-present in our lives and affect almost every decision, reaction, and situation we encounter. Market changes, volatility, and chasing gains can cause disappointment, frustration, and panic at the lows and excitement at the highs—and these feelings can overpower rational thought. Some people have a hard time ignoring the emotional pull to buy or sell according to market trends and during volatility. After all, your hard-earned dollars are on the line, and the fear of losing money is genuine (in fact, studies have shown that “the pain of losing is psychologically twice as powerful as the pleasure of gaining,” and this loss aversion only grows stronger as the stakes get higher).
Take, for example, findings from a study by DALBAR, which showed that: “The average investor was a net withdrawer of funds in 2018 but poor timing caused a loss of 9.42% on the year compared to an S&P 500 index that retreated only 4.38%.” Cory Clark, DALBAR’s Chief Marketing Officer, said, “Judging by the cash flows we saw, investors sensed danger in the markets and decreased their exposure but not nearly enough to prevent serious losses. Unfortunately, the problem was compounded by being out of the market during the recovery months. As a result, equity investors gained no alpha, and in fact trailed the S&P by 504 basis points.”
Warren Buffet said, “Be fearful when others are greedy, and greedy when others are fearful.” Easier said than done: We naturally “follow the herd”—this instinct is what has kept humans alive for millennia as there has been safety in numbers. We are also naturally emotional creatures—a core aspect of the human experience. But these two things that make us human collide when it comes to finances and investing, often causing us to buy high and sell low. Acknowledging that you are a herd animal and the powerful impact your emotions have on almost every aspect of your life will help you push past your natural instincts and make sounder investment decisions.
Our investment advisors often hear questions deeply based on emotions:
- Will be my spouse be okay if I die first? Will I be okay if they die first?
- Will we outlive our retirement income?
- How will we pay for medical care in retirement? What if we need long-term care?
- What happens if a market crash or recession occurs again? Will our money survive?
These are crucial questions to consider and justifiably emotional, but knee-jerk reactions to market adjustments and life situations can lead to poor—and emotional—decision-making instead of well-considered decisions that align with your overall long-term goals and strategies. So, how can you avoid this emotional investing?
How to Avoid Emotional Investing
Start with your goals.
What do you hope to accomplish financially? What are your long-term financial and retirement goals? Write down your goals and use them as your guiding light when building out a plan and making any investment decisions.
Develop a long-term financial/retirement plan.
Once you’ve identified your goals, create a comprehensive plan that incorporates them and draws a roadmap for how you’ll achieve them. A financial professional can help you build a diversified portfolio that aligns with your risk tolerance level to meet your immediate, short-term, and long-term goals.
Make diversification a priority.
Spreading your investments among different asset classes (e.g., ETFs, bonds, real estate, etc.) or across different industries and businesses is a way to lower your portfolio risk and can help you weather market corrections and volatility. Diversification reduces the chances of taking a major hit when one asset experiences a loss. This can also help reduce your gut reaction to panic sell when the value of a stock or other asset class goes down.
Educate yourself on market trends, companies and sectors, and other financial concepts and products important to your overall investment strategy.
Understanding market corrections and volatility, bubbles, bull and bear markets, insurance products like annuities, and investing strategies can help ease the stress (and sometimes overexcitement) you might feel when the market moves. Market peaks and valleys typically even out over the long term, so understanding this can help avoid a short-term reaction on your part. Sometimes, doing nothing when the market drops is the best course of action.
Don’t let the media dictate your decisions.
Just take a look at newspapers and news sites on any given day, and you’ll likely find hype and sensationalized headlines like “Stock Market Crash Coming Soon? You Need To See These 2 Charts” from Forbes and “Dow Tumbles 700 Points for its Worst Drop Since October” from CNBC. Use media outlets as a tool to stay up to date on the market and financial information, not as your sole source of advice and information upon which to base your investment decisions.
Don’t let FOMO get the best of you.
The herd mentality can derail your long-term financial plan. Some of the options the herd is investing in have fleeting gains, so by the time you decide to get on board with what others are doing, the moment may have passed. Don’t follow along just because everyone else seems to be doing it. Don’t be a sheep! Do your due diligence, research, and enlist the help of a professional.
If you decide to change your portfolio, examine why you’re making that decision.
Are you following the herd or chasing a gain? Are you reacting to a short-term market change or media coverage? Answering yes to these questions means you’re likely making an emotional decision. Have you considered your long-term goals and strategy, consulted with your financial professional, and evaluated any corresponding data? If so—and your answer is still yes—you’ve likely made a prudent decision.
Keep the end (and your long-term goals) in mind.
Remember, the prize at the end is to have enough money saved to meet your personal and financial goals and live the retirement of your dreams. Short-term market volatility will likely have little to no impact on the long-term goals you’ve set. Having a well-managed portfolio and staying invested can help you avoid losing money over a longer time horizon.
Allow yourself to spend a bit of time with your emotions.
Feel your emotions for a few minutes. Try to understand what’s driving them: Did you lose money in your investments, causing panic and stress, or make a big gain, causing an emotional high? Then, decide what action you could take that might bring your emotions in check. Do you need to schedule time with your advisor to discuss your situation? Do you need to reevaluate your risk tolerance? Do you need to do some research on a stock or other aspect of your portfolio?
Spend some time with your decisions before acting upon them.
Obviously, some moves need to happen quickly but sit with them for a bit before making the moves. Even better, consult a trusted friend or financial professional and bounce your thoughts off of them.
According to RBC Global Asset Management, consider some big-picture questions like these:
- Have my goals changed now that my investments have declined?
- Is my investment time horizon the same as it was when my portfolio was built?
- Has my financial situation changed?
- Is my portfolio aligned with my risk tolerance? Or has my risk tolerance changed?
- Is my portfolio appropriately diversified?
Your answers to these questions can help drive (or not drive) changes to your portfolio after careful reflection and consideration.
Work with a professional.
A financial professional (tax and legal, too) can help you navigate the complex financial landscape, align and diversify your portfolio to meet your short-term and long-term goals, and offer valuable perspective and advice when you feel your emotions creeping in. They can also help you strategically rebalance your portfolio if you deem a change necessary. Look for a fiduciary who is obligated to put your best interests first. If you’re feeling anxious or like your emotions are creeping into your psyche, reach out to your financial advisor for a more neutral party’s opinion and to discuss if your decision-making is based on emotions rather than logic and reason.
Don’t check your retirement accounts as often.
Looking at your accounts daily can quickly elevate your emotions and cause short-term changes to affect your long-term plan. Checking your accounts monthly or quarterly can show you how your accounts are performing over time. According to an interview conducted by Athene with Bryan Kuderna, a certified financial planner with the Kuderna Financial Team, “If you are watching the markets every day, it can put you on a roller coaster ride of ups and downs. And when that happens, you tend to make bad decisions with your money.”
According to Daniel Crosby, a behavioral finance expert and the executive director of Brinker Capital’s The Center for Outcomes, via US News, “A daily look at portfolio values means you see a loss 46.7 percent of the time, whereas a yearly look shows a loss a mere 27.6 percent of the time.”
Past performance may not be indicative of future results.
You commonly see this phrase in financial companies’ disclaimers for a good reason: Nothing is ever guaranteed. The stock market always has some risk, and some stocks and investment vehicles are riskier than others. Comfort with some level of loss may be necessary to add long-term value to your portfolio. Don’t make assumptions, and keep doing your research.
Money is emotional, and we are emotional beings, but making these tips work for you can help you check your emotions at the door when it comes to your financial decisions.
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Ally. (2019, September 20). 6 Ways to Avoid Emotional Investing. https://www.ally.com/do-it-right/investing/how-to-avoid-emotional-investing/
Athene. (n.d.) Take emotions out of retirement planning. https://www.athene.com/smart-strategies/finances/take-emotions-out-of-retirement-planning.html
Brecht, Kira. (2017, February 7). How to Avoid Emotional Investing. U.S. News. https://money.usnews.com/investing/articles/2017-02-07/how-to-avoid-emotional-investing
Clark, Joe. (2021, March 6). Joe Clark column: Taking the emotion out of financial decisions. The Herald Bulletin. https://www.heraldbulletin.com/opinion/columns/joe-clark-column-taking-the-emotion-out-of-financial-decisions/article_1665db24-7d01-11eb-b959-cb23876d32c4.html
DALBAR. (n.d.). Average investor blown away by market turmoil in 2018. https://www.dalbar.com/Portals/dalbar/Cache/News/PressReleases/QAIBPressRelease_2019.pdf
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RBC Global Asset Management. (n.d.). How to avoid emotional investing: Tips to help you stay focused on the big picture. https://www.rbcgam.com/en/ca/learn-plan/investment-basics/how-to-avoid-emotional-investing/detail
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