Keep your head: Overcoming the emotions of investing
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As human beings we tend to make decisions based on our emotions. We like to think we’re rational, logical decision-makers, but we’re not. And research tells us that when it comes to investing, our emotions are costing us a lot of money.
DALBAR is an American research firm that was founded in 1976. For the past 25 years they have been running an annual study into investor behaviour. According to this research, there is a difference between investment returns and investor returns. Investors consistently earn lower returns than the markets they invest in.
That happens because our emotions can lead us to buy investments when they are priced high and sell them when prices are low.
The behaviour gap
The difference is what financial advisers call the ‘behaviour gap’ and during periods of market turmoil, it can be huge.
As an example, during 2018 the average share investor in the US experienced returns more than 5% lower than the market actually achieved.
We’re not rational
When markets go up, our confidence goes up as well. We tend to attribute the gains to our skill, and this leads us to increase our risk exposure, or contribute more to our investments. We don’t want to miss out on the rising market, and this can lead us to pay prices for investments that have no basis in reality. That is how we experience a market boom.
But booms inevitably bust. And when markets fall, investors can panic. It’s hard watching your investments fall in price and know that you’re losing money. The media makes it worse, bombarding us with bad news.
We want to stop feeling the pain of losing money, so we sell our investments after the prices have fallen.
And that’s a formula for wealth destruction.
The value of good advice
A financial planner can help you solve the behaviour gap. CoreData research shows that people who have an active relationship with a financial adviser are better off because they make better financial decisions. They’re also more likely to avoid bad decisions.
Part of that is because they’re better informed, but mostly it’s because there are mechanisms in place to counter the emotions of investing.
A framework for success
At When Financial Solutions we use a framework to help you manage your emotions when you’re making financial decisions.
We consider more than just your super. We think about your entire circumstances, including your housing arrangements, your money inside and outside of super, your entitlements to the age pension, your health as well as your family.
We take the time to understand your attitudes to risk and your financial capacity to take on risk. We then make sure you have enough money to live on for several years. This releases you to take a long-term view of your money, so you don’t have to worry about selling when prices are low.
When you get advice from us when markets are strong, we will always seek to lock in profits where possible, so that you take the minimum risk required to achieve your goals in retirement.
That’s how we hold our clients accountable, so they don’t lose their heads when markets are tumultuous. Because when you deal with us, it’s not a matter of ‘if’ you will feel secure in your retirement but ‘when.’
Michael Bowman and James McMaster are co-founders of When Financial Solutions. This article is general and does not consider your personal circumstances. If you would like advice specific to you please give us a call.