Dagger Money Talk: Becoming a Better Investor Through Understanding Your Emotions

By Adam Freeland, CFP and Evelyn Ishmael
Special to The Dagger

Do you find investing to be a scary experience? Do your emotions rise and plummet like the turns on a roller coaster? If so, you are not alone. Many investors have found the extreme volatility of the stock market very unnerving. Many would just like to throw up their hands and avoid the financial markets completely. However, since many companies have eliminated traditional pension plans and concerns of the solvency of Social Security, most of us have been forced to take change of our financial future. Although ample efforts have been made to provide better investor education, many Americans have put their long-term financial goals in jeopardy by earning below-average market returns in both stocks and bonds.

Most investors want to buy low and sell high. So why do we do the opposite? The primary reasons stem from making decisions based on emotions. Those emotions range from excessive pessimism, such as panic selling and extreme risk aversion, to buying into tops of bubbles and taking undue risk. We follow the herd; react to the 24/7 news cycle; vacillate between giddiness and regret and the beat goes on. Our biological and psychological impulses work against us but we need to push back.

Many folks sell when the markets are falling and buy when the markets are rising. It may help to know as volatile as it may be, the stock market has produced some of the highest returns over other investments for the long term.

Dalbar, Inc., the nation’s leading financial services market research firm, found this to be true. In a recent study, a $10,000 invested in the stocks that comprised the S&P 500 in 1989 would be worth $57,501 in 2009 for an annualized return of the stock market was 9.14%. By contrast, the average stock mutual fund investor who typically trade in and out of the market earned just 3.83%.

Actions to Take

So how can you push back when your biological and psychological impulses work against you? It’s not fruitless!! Individual investors have been able to reach their financial goals by following some key principles:

1. Determine if you can do it yourself or if you need a “financial coach”. Some people have the determination to research and monitor their investments, and the fortitude to withstand the ups and downs of the markets. Marketing efforts by the financial service industry might try to persuade to either to invest on your own or with an advisor who acts like a coach. Decide for yourself which works best for you.

2. Know your financial goals and understand that there will be ups and downs along the way. Think of some of the major successes in your life – finishing school, getting married, raising your kids, and completing major projects at work. You visualized what you wanted to accomplish and you stuck to it even during tough times. As Marylanders, we warn others to Fear the Turtle (Go Terps!). Perhaps we should adopt a the mindset of tortoise instead of the hare.

3. George Constanza and Warren Buffett In a famous episode of Seinfeld, George Constanza, the loveable loser, enjoys great success by going against his natural impulses. Channel your inner George Constanza, fight your natural instincts, and follow the advice of Warren Buffett who said,“Be greedy when others are fearful and fearful when others are greedy.”

4. Use the Bucket Approach – Segment your money mentally into different buckets that are for short-term, medium-term, and long-term goals. By taking this approach you can have peace of mind your short-term goals are met while letting investments for the long-term move up and down without affecting your current standard of living.

Investments for the short-term bucket are for bills and expenses within a year to five years. This bucket usually contains investments like bank accounts, CD’s, money market, and short and intermediate-term bonds. Investments in the intermediate bucket are for goals from five to ten years like college, car, or major vacation. They can be a mixture of cash, bonds, and stocks. Investments in the long-term bucket are for goals over ten years like retirement. It tends to have significantly higher allocations to stock.

5. News Can Be Hazardous to Your Wealth. News can be titillating, sensationalized, biased and short-term focused! Examine the reliability, authenticity, and applicability of the news to your long-term financial goals. Stay informed but do not overreact to short-term news cycles that may jeopardize your long-term plans.

6. Looking at it More, Won’t Make it Grow Faster. Be careful on how often you check your investments. Looking at accounts frequently can lead to making rash decisions as it moves up and down. Unless your investment approach is predicated on high frequency or day trading, monitor your investments on monthly or quarterly basis.

7. Be Careful of the “Perfect Investment” – The “Perfect Investment” exists somewhere between the Garden of Eden and Utopia which means not at all. In order to escape the volatility of the stock market, some are drawn to promises of high guaranteed rates of return with no loss of principal. All investments contain some form of risk or have disadvantages even those deemed “safe” like cash, annuities, or life insurance. Be wary of any sales pitch that only emphasizes the “upside” of an investment without the “downside”. If it sounds too good to be true, it probably is.

Investing for your long-term goals can be challenging due to the volatility of the financial markets. The constant ups and downs can be nerve wracking, By following some simple steps, you can make better decisions by understanding how our emotions and impulses affect us and ways to manage them.

Adam Freeland is a Certified Financial PlannerTM with Harford Financial Group located in Bel Air, Maryland.

Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a Broker Dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Harford Financial Group and Cambridge Investment Research, Inc. are not affiliated.

Adam Freeland will appear on WAMD 970 AM radio at 7:30 a.m. Wednesday to discuss his investment column. Listen or watch the discussion live on WAMD 970.