This article about emotional investing is part two of a four-part blog series about training yourself to make better financial decisions.
“The challenge for all investors is to consume the news without being consumed by it.” –Jason Zweig
In my last post, I introduced a four-part blog series on the importance of separating fact from fiction as an investor. Building on this topic, today I’m describing how negative emotions can impact our ability to make sound financial decisions. More importantly, I’m giving you a three-step strategy to avoid these pitfalls so you can make better decisions.
How to Avoid The Common Pitfalls of Emotional Investing:
1. Recognize Your Emotions
Our current culture of information overload—combined with unprecedented newsworthy events over the past year—has made understanding our emotions and their influence on decision-making even more important. Indeed, fear and uncertainty can be an investor’s worst enemies. And although it seems there’s been no shortage of either lately, that doesn’t mean we need to turn our emotions off altogether.
For example, many of us may be grieving the loss of the “normal” life we had before the start of the pandemic. If so, it’s important to acknowledge these feelings. In a recent National Public Radio piece, behavioral counselor Sonya Lott explains how unattended grief can impair “every aspect of our being – physically, cognitively, emotionally, spiritually…” (and financially, we might add). Lott says, “We can’t heal what we don’t have an awareness of.”
In other words, emotions—even strong ones—aren’t inherently good or bad. However, it’s important to be aware of these feelings so we don’t put them in the driver’s seat when making important financial decisions.
2. Understand the Pitfalls of Emotional Investing
Behavioral finance is an extensive field of study dedicated to understanding how our instincts and emotions often interfere with our ability to make rational financial decisions. Of course, behavioral finance has many potential implications on investor behavior. However, suffice it to say here, every investor faces strong, hardwired temptations to:
- Chase illusory trends
- Fear the very investment risks that are expected to generate our greatest rewards
- Regret even our most sensible decisions in the face of minor setbacks
- Disregard durable data
- Overreact to breaking news and emotion-triggering language
Put differently, strong feelings, while natural, will create cognitive blind spots in your reasoning. Moreover, we are all susceptible to these blind spots as investors and human beings. The good news is, once we recognize these potential pitfalls in our reasoning, we can put systems in place to combat them.
3. Keep Your Emotions In Check
So, as an investor, business owner, and individual, how do you navigate past potential emotional traps? Above all, it can help to have an objective advisor point out and manage your behavioral blind spots. But you can help yourself as well.
First, make sure your financial plan is guiding your investment decisions, not news headlines or social media. If you’re a long-term investor, short-term setbacks shouldn’t affect your overall investment strategy. In fact, overreacting to these setbacks can do you more harm than good.
Second, if you start to feel like your emotions are taking hold of your thoughts, hit the pause button before making any important decisions. In other words, let the heat subside and do a little more research on the issues causing you anxiety before deviating from your overall strategy. Alternatively, commit to only checking the status of your investment accounts once per month, quarter, or even year. Doing so can help you stick to your financial plan and avoid the temptation of taking unnecessary action.
Finally, if you find your emotions are continually getting the better of you, you may need to adjust your investment plan to better accommodate your appetite for risk. An experienced financial planner can help you develop a strategy that’s easier for you to stick with over time.
If you don’t yet have a financial plan or investment strategy, we may be able to help. Start by requesting a free retirement assessment.