by Ralf Sellig
Do Your Emotions Hinder Your Investment Results?
As humans, we are all driven by our emotions. This is especially true when it comes to our finances.
Even the most steadfast investor who has the best intentions of making wise, careful decisions can be shaken by a market drop or the right headline. This can make Do It Yourself investing very difficult, because when it comes to finances, emotions often override logic.
In our experience, people have strong emotions about their money. You work hard for your money, so if your portfolio loses value, it’s common to panic and think, “If this continues, I won’t have enough money to live.” Our emotions want to protect what we have. However, the reality of the situation might not be as bad as we perceive it.
Emotions can also hinder investment results when the market is performing well.
After long periods of big gains, our emotions tend to calm down. We no longer perceive imminent danger, and it’s natural to not want to miss out on an opportunity to make money.
Investing on your own can be an emotional rollercoaster. There’s no advocate on your team who will bring you back to zero.
When you’re first getting started, you may feel positive, confident, optimistic. When you experience success for the first time, you’re thrilled, excited, maybe a bit surprised.
Market drops tend to create fear, worry and stress. We’ve all heard an investment horror story that we remember, and at these times, we start to envision them for ourselves. However, an industry professional knows that the market will continue to have ups and downs. And an outside, objective and educated perspective can make all the difference. A financial advisor you trust can help you focus on your long-term goals and provide a peace of mind that your financial well-being is taken care of.
Emotional decisions to sell because of panic or buy on euphoria can detract from long-term performance.
While it’s impossible to turn our emotions off, we can moderate our behavior by understanding our emotions and leaning on people we trust.
At Lucas Capital Management, we look at our clients’ risk tolerance and create portfolios that are appropriate for each client’s situation. When you have the right asset allocation, it’s easier to live through the emotional ups and downs without panic.
Schedule a free, no-strings-attached check-up with the financial advisors at Lucas Capital Management.
Remember, Investing is a Long-Term Process
Our emotional instincts sometimes lead to poorly timed investment decisions, based on short-term market moves. Our fight-or-flight instincts cause us to react as oppose to respond.
Research consistently shows that the average investor earns below market returns, and the reason is usually bad decision making. In fact, far more money has been lost by investors preparing for market changes than in the market itself. And unfortunately, modern technology and immediate reports make this even more difficult to avoid. “Information” is everywhere, portfolios can be checked constantly and financial hype is unavoidable.
But the stock market rewards long-term investors. It rewards those who can see the forest through the trees. The timeframe for investing is usually years; not days, which is why having a financial plan is crucial to success.
There is a science behind emotional investing. Behavioral finance is the study of how people feel about money and why the react the way they do.
Here are 5 ways your emotions can hinder your investment results:
Taking Too Much Risk
It’s common for investors to take the wrong amount of risk in their portfolios.
We meet with clients who may have thought they were diversified and taking less risk than they actually were, either because they failed to review their risk tolerance, they never found their true risk tolerance and therefore thought they could handle more than they actually could or they simply didn’t understand the level of risk they were taking.
It’s easy to find simple, quick, 5-question risk tolerance tests online, but we can confidently tell you that that doesn’t even begin to scratch the surface. A thorough risk tolerance assessment by a professional financial advisor is key. Your entire situation, financial goals, concerns and life events should be taken into consideration and not just your age or phase in life.
At Lucas Capital Management, we take risk tolerance very seriously. In fact, we believe that risk management is one of the most important things that your financial advisor does for you. That’s why we integrate risk management into all of our financial planning and investment management processes.
Keeping a close handle on risk helps you avoid costly mistakes. Understanding your risk tolerance is vital self-defense against common emotional investing mistakes that can be very damaging to your financial future.
Overconfidence is another common mistake – telling yourself you can do it all, when you shouldn’t, or can’t.
Most people agree: If the roof is leaking on your house and you’re not a roofer by trade, you’d hire a professional. Why isn’t this thinking the same when it comes to your finances, your future and your heirs?
Fear of Failure
Hindsight bias is a real thing. While many investors take too much risk in their portfolio, others don’t take enough. Maybe they lost money before and are paranoid of experiencing a similar loss. But this all comes back to your risk tolerance. Having a financial advisor assess your portfolio can offer the peace of mind you need.
False assumptions are also common, which is why it’s so important for investors to educate themselves.
Education is another priority of ours at Lucas Capital Management. We publish regular articles to our blog every month and take time to review and explain our clients’ portfolios.
Reacting as Opposed to Responding
Reactions are knee-jerk responses to emotions we have – the market dropped, so our initial reaction is to sell.
Responses, on the other hand, are thought-out decisions based on information – when the market drops, we discuss the situation with our financial advisor and decide together the best action to take based on our long-term goals.
Responding to situations instead of reacting can make all the difference.
If you’re looking for a financial advisor in New Jersey, contact us to see how we can help.