Regardless of how long you have been investing, many evolutionary characteristics can make being a patient long term investor difficult. As you hear unsavory news about a company you’ve invested in, your first instinct may likely be to sell your shares, this is similar to your fight or flight response. Yes, their stock may drop in the following days or weeks, but it is important to recall that, as famous investor and Warren Buffett teacher Benjamin Graham said “In the long run, the stock market is a weighing machine… but in the short run, it’s a voting machine”.
Selling your stock now based on an emotional response could mean you miss out on significant earnings years or decades later down the line. Before you risk that chance, we have four easy tricks you can use to help avoid investing with your emotions.
Working with an advisor can be your first line of defense against behavioral investing. Some investment advisors or financial planners may act as a behavior coach. In doing so, they can prepare you ahead of time to react calmly and unemotionally in times of market change. If you do tend to take an emotional approach to your investment decisions, you may find that an extra set of eyes on your portfolio to be worth it. Sometimes, just voicing your concerns is enough to help stick to the long term plan!
Speaking of plan! Do you have a favorite chocolate chip cookie recipe? You’ve made it so many times, the recipe is practically etched into your head. But let’s say you go to make them, and you get a bit distracted. With your focus astray, you may start to question what you thought you definitely knew. Was it ¾ cup of sugar or a half? I swear I bake these at 375 degrees, but now I can’t remember for how long. Before you begin to panic, you can grab the cookbook and double-check the recipe. Within minutes, you have total peace of mind that you added the right amount of sugar and set the timer correctly.
Think of your investments in the same vein. Putting your investment plan in writing can provide you with that same reassurance when doubts arise and your emotions begin to take over. If you’ve made a proper, thoughtful investment plan, you have likely already prepared for the good and the bad. Seeing this in writing can provide the relief that you’re doing the right thing. As we often say, if you do not know where you are going, any road will get you there. Better to know before hand where exactly that is!
There was a study conducted in 1979 that introduced the “loss aversion” principle. This principle is used to describe instances where the weight of a loss is greater than the benefits of a reward.1 For many investors, this principle can hold true - they feel much worse about a loss in value of their stocks than they feel happy when those stocks are performing well. If this sounds like you, it might be time to take a step back from your portfolio. While regular review and rebalancing is often necessary, you may want to resist the urge to check on your stocks too frequently (daily, weekly or even monthly). With the loss aversion principle in mind, doing so may lead to more frustration than elation. This could easily entice you to make an emotionally driven decision regarding your investments. Further, when you do check, your balance is not likely to be up every time you view it. This is not necessarily an indication of a problem. Having metrics to make sure things are going to plan is helpful in this regard.
Depending on your depth of investment knowledge, you may already know what a bull market (on the rise) and a bear market (falling downward) are. But if you’re looking to better prepare yourself emotionally, you may want to do a bit of research into what historically happens in each market type. How long they tend to last, the trends leading up to either market type and the recovery time (in cases of loss), for example. Taking a historical view of the market can help you separate yourself and your stocks from the greater picture. This has the potential to make your investment decisions less behavior-based as you become more informed about past trends. It is often said that history does not repeat, but it does rhyme. Having a good view of history may offer some peace of mind that the movements happening now, have happened before and it could guide you on what may happen next. Not quite as good as the benefit of hindsight, but it may help you be more mentally prepared!
Removing your emotions from your investments is easier said than done. And in some instances, it can actually be beneficial to take stock of how market changes make you feel. For example, your comfortability with a market downturn can help you understand whether or not your risk tolerance is at the appropriate level. We have observed with clients over the years that the feeling of risk tolerance can change depending on the environment. Having these conversations with your financial advisor often can help focus on your plan, goals and risk tolerance when the sun is out and things are calm!
sources: 1. https://www.apa.org/science/about/psa/2015/01/gains-losses