Emotional Investor
/One of the things I enjoy most about being a financial planner is getting to learn what money means to each and every one of my clients. What motivates them, why they handle money in certain ways, and how they want their futures to look are all important aspects of the financial planning process. No matter who I speak with, however, money always has some kind of emotion attached to it, especially when it comes to investing. They say money can’t buy you happiness, but it sure can be a source of a whole host of other emotions. The truth is, we are all emotional investors, whether we realize it or not.
One subconscious emotion that investors may want to be aware of is recency bias. This refers to a cognitive bias that gives greater importance to recent events than to historical ones. It is human nature to have some kind of bias related to just about every decision we make. Those that tend toward recency bias make investment decisions based on current events, rather than looking at the bigger picture (the historical aspect) and the potential for change in the future. This means they may react to things, like the recent market correction, by selling their investments because they believe the market will just continue to go down and they want to “stop the bleeding.” The problem with this type of strategy is that none of us actually know when the market has hit the proverbial “bottom” and staying invested has proven over time to be more beneficial for long-term investors. To combat this, remember the phrase, “When in doubt, zoom out.” In other words, remember to look at a longer history of investing and realize that market corrections and bear markets eventually lead to bull markets, which is where you’ll make money.
Another emotional behavior for investors to watch out for when making investment decisions is confirmation bias. This is the tendency to seek out information that confirms their already existing opinions, rather than looking for views that are contrary to their own ideas. It can cause an investor to think because they purchased an investment in a particular industry or sector and it performed well, that is the only part of the market they should be invested in, which can lead to things like concentration risk. A way to combat this might be to look at the long-term returns of that particular industry or sector and compare it to similar data for a more broadly diversified index fund or other sectors of the market to see what other opportunities exist.
Having a long-term investment plan and sticking to it becomes even more important as we experience the pain the markets are currently doling out. Whenever you’re making investment decisions, it’s best to leave your emotions out of it. For many, that means working with an advisor who can help you make rational decisions and guide you in the right direction toward a diversified, disciplined investing approach.
- Margaret Gooley, CFP®, CDFA®, Worley Erhart-Graves Financial Advisors
