One of the first things Mike Fenison, the founder of Pure Financial Advisors, told me in the early days of the company was that you can’t overcome emotion with logic. Being a former engineer, this presented quite a dilemma for me, because I tend to explain things in what I believe to be a very logical fashion. Financial decisions, however, tend to be emotional. Most people will deny that that’s how they make their financial decisions, and they won’t believe you if you point it out. (Believe me, I tried, back when I thought people might appreciate me helping them discover that about themselves.) It was very enlightening for me to discover how people repeat the same cycles of financial underachievement because they won’t admit one of the biggest hurdles they have to overcome.
My hope in writing this blog is to arm people with what I believe to be logical weapons against their tendency to react emotionally to financial issues. If you can’t overcome emotion with logic, maybe I can help keep some of the emotions at bay before they have a chance to turn into an insurmountable barrier. Despite enormous evidence that our founder was right on the money with his original advice, I refuse to accept it entirely (and that’s probably an emotional decision in itself, no one is immune!)
Fear and Greed
The most basic emotion when it comes to finance is the fear/greed influence. At least one Nobel Prize in economics identifying this effect has been awarded. In general, the greatest number of people are buying stocks when markets are at their peak (greed), and the smallest number are buying when they’re in their troughs (fear). It’s like going to Nordstrom during the annual sale and asking the salesperson to hold your favorite items until the sale is over, so you can come back and buy them at full price. It’s completely illogical!
The problem with investing, of course, is you don’t really know when something is on sale, the actual market cycles are unpredictable. That’s why we educate people on staying fully invested in a globally diversified portfolio and using a structured rebalancing process. It eliminates the need to “time” anything. That automatically results in taking profits from assets that have gone through a significant growth cycle (sell high), and/or buying more of the assets that have been in a cycle of under-performance (buy low). That’s been shown to reduce volatility and speed up recovery time in down markets.
9 Investment Pitfalls All Investors Should Avoid – Download the Free Whitepaper
How To Keep Emotions At Bay
Although our emotions will always be with us when making investment decisions or decisions of any other kind, there are a few things we can do to ensure they don’t take control of our portfolios and potentially prevent us from meeting our financial objectives:
Having a diversified portfolio is one way to avoid making emotional financial decisions. You can focus less on the “when” and “what” of investments. You are likely to use emotion to make these decisions. Focusing on keeping your diversified portfolio balanced can be approached from a more objective standpoint. To start, we need to know what we would like the overall balance to be from the beginning. Once this decision is made, responding to market changes not with a crystal ball to determine future moves but with an eye toward rebalancing can help us reduce some of the negative effects of emotional decision making.
Establish Financial Goals
By having your goals written down prior to making investment decisions, you have a benchmark to judge the progress you are making that is appropriate to your situation. Too many investors are concerned with abstract goals such as outperforming the market or achieving a certain numeric return, but the achievement of these goals may or may not meet your financial objectives. By stating your goals upfront and monitoring your progress toward fulfilling them, you have a framework within which you can guide future decisions.
Making the Best Possible Financial Decisions
As you can see, many of the tools we have at our disposal to keep emotional decisions at bay are process related. Once you have established a reasonable investment strategy that fits your needs, putting yourself in the position to evaluate how closely this process is being followed can be a lot easier than second-guessing each individual investment decision on a one by one basis.
Neither this approach nor any other can guarantee that we make successful investment decisions. As with any decision-making process, there is uncertainty. This doubt can lead to rationalizations and second-guessing that can be counterproductive. It can be tempting to want to change direction as soon as decisions do not go as planned. Resist the urge to do so and focus on your long-term objectives, using the strategies you’ve developed to assist you. We will never get rid of fear and greed. We can, however, try to minimize the potentially negative impacts they can have on our financial goals.
The strategies to keep emotions at bay are pretty simple, I think, and information most folks have heard before. It never hurts to reinforce the basic concepts, though, and hopefully, everyone likes the “logic” idea. I also believe this furthers Pure Financial Advisors’ goal of helping people make the best decisions they can, in every financial area of their lives, all the time. It’s logical that people would be a lot better off if they did that, right?