We all like to think we make our decisions based on facts and logic. But unless you’re a robot, that isn’t the case.
Emotions always play some role in the choices we make, including — maybe even especially — when it comes to our money. And it’s no wonder, when so much of our self-worth is tied to our net worth.
That’s why the financial industry is so interested in the fields of behavioral economics and behavioral finance, studying the social, cognitive and emotional factors that can lead investors to depart from rational decision-making.
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No one is perfect
Researchers have identified dozens of behavioral biases that can come into play as investors try to determine the best ways to both grow and protect their assets. There’s pride, regret, anger, fear and greed, just to name a few. Unfortunately, those emotions can lead to actions that are more destructive than constructive. If you can learn to contain them, you’re bound to lessen the negative impact on your portfolio.
That’s easier said than done, of course. Or, as Richard Thaler, the winner of the 2017 Nobel Prize in economics, puts it, we humans are consistently irrational.
Oh, how we hate to lose
Much of this irrationality can be attributed to the effect that losses have on our emotions — what researchers call loss-aversion bias. We feel the pain of a loss much more than the joy of a gain — particularly when it comes to our hard-earned money. And that can trip us up. For example, an investor might not be willing to get rid of a bad investment and switch over to a product or strategy with more potential.
The lemming factor
Another common mistake is to follow the herd. Again, it’s human nature to go with the latest trend; if everybody’s doing it, it must be a winner, right? Not necessarily. When investing your nest egg, you should do what’s best based on your unique goals. Many people put their money into investments without regard to how long it will take to recover from a loss — which can be devastating if you’re in or near retirement. Or they make an investment, then over-monitor and agonize about it, which could lead to buying high and selling low. “Fear of missing out” can take a chunk out of a portfolio at the most inopportune time.
In bull markets we trust
And then there’s the kind of over-confidence we’re seeing a lot of these days, thanks to this record-setting bull market. This is another significant problem for pre-retirees, who should be transitioning from the accumulation phase of their investing career to the preservation and distribution phase. It’s imperative that they move to a portfolio that is structured to last the entirety of their retirement — which could be 25 years or more. The impact of a downturn can be much more calamitous in retirement than when you’re working, especially if you’re depending on your investments for a portion of your income.
You’re likely wondering at this point if there’s some way you can channel Star Trek’s Mr. Spock, putting emotions aside and becoming super-rational — at least when it comes to your finances.
Probably not.
And that’s not all bad. Your brain uses emotions to convince you to act in a certain manner. So why not harness those feelings and use them in a positive way? If you are feeling anxious regarding current market trends, talk it out with your financial professional. The main thing is to keep your sights on your retirement income goals and refrain from making changes that don’t align with those goals.
The bottom line
No matter what’s driving you — fear, greed, pride, envy — do your homework, ask questions, read the fine print. And seek help from a financial professional, preferably a fiduciary who specializes in creating income in retirement and can help you protect your nest egg and your future income.
Kim Franke-Folstad contributed to this article.
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