With today’s economic uncertainty and market volatility, it’s important to understand the emotions that drive your investing decisions. Whether it’s greed, fear, optimism or something else, knowing what motivates you can help you avoid making mistakes.
Or, as Warren Buffett puts it, “Only when you combine sound intellect with emotional discipline do you get rational behavior.”
It takes all types to make the market run, but some approaches are more likely to lead to long-term success than others. Ask yourself which of these mindsets is most like yours:
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The Gambler
The gambler is usually looking to get rich quick or with little effort. For example, the odds of winning the grand prize in Powerball are 1 in 292,201,338; there’s no mathematical justification for buying a ticket. And yet, somebody’s going to win — and it could be you. So you play. That’s gambling.
In the world of options trading, most people are gamblers. Hoping that one big win will change their standard of living, they tend to put too much of their net worth behind their trades. They don’t pay attention to probability, and they don’t work out the odds.
If you gamble in the stock market, you might get lucky once in a while, but in the end, there’s a strong risk of losing.
The Speculator
Speculating involves taking a calculated risk with an uncertain outcome. It can be fine now and then, in the same way that going to a casino might be fun once in a while. But if it starts to consume you and you’re spending money that you can’t afford to lose, then it becomes a problem. You should thoroughly understand what you’re getting into and be prepared to lose all the money invested.
For most people, most of the time, that means speculating is inappropriate. Mark Twain says it this way: “There are two times in a man’s life when he should not speculate: when he can’t afford it, and when he can.”
The Investor
Investing is, of course, very different from gambling or speculating. It involves a process: learning fundamentals, doing some research and having confidence in a company’s financial details.
A careful investor makes decisions based on sound information, not hope or emotion.
Here’s another Buffett quote: In 2006, he told shareholders, “You have to be able to play out your hand under all circumstances. But if you can play out your hand, and you’ve got the right facts, and you reason by yourself, and you let the market serve you and not instruct you, you can't miss.”
That means a smart investor doesn’t just look at a price and say, “OK, that must be what the company is worth.” He estimates the actual value of the company based on his research, or the research of a trusted financial professional.
Investing does involve risk, including the potential loss of principal, since no strategy can guarantee a profit, and few protect against loss in periods of declining values. The key is to not get emotionally involved. An investor asks, “Can I make a good decision today to buy this asset based on sound information?” If the answer is yes, he moves forward.
The Risk Manager
As a person approaches or enters retirement, his thinking has to shift. Accumulating assets is no longer the goal; converting assets to income is what’s important.
Risk tolerance should be a factor for investors of all ages, but for those in or near retirement, it must be a primary focus. With little or no time to recover, a large loss can destroy your nest egg.
The risk manager thinks about what can be controlled in retirement ‐ and that’s certainly not the markets. It’s a matter of what portion of retirement assets should be in market-based assets (stocks, bonds, mutual funds, etc.) and how much should be in alternative assets (indexed annuities, real estate, commodities, etc.). Volatility is the enemy; diversification is the risk manager’s friend.
Did you spot yourself in any of the above investment approaches? Maybe you’re a mix of two or three, or even all four.
The trick is to be self-aware whenever you’re making a money move. Ask yourself each time, “Am I being a gambler, a speculator, an investor or a risk manager?” You just might save yourself from making a retirement-wrecking mistake.
Kim Franke-Folstad contributed to this article.
-
Stock Market Today: Have We Seen the Bottom for Stocks?Solid first-quarter earnings suggest fundamentals remain solid, and recent price action is encouraging too.
-
Is the GOP Secretly Planning to Raise Taxes on the Rich?Tax Reform As high-stakes tax reform talks resume on Capitol Hill, questions are swirling about what Republicans and President Trump will do.
-
Social Security Is Taxable, But There Are WorkaroundsIf you're strategic about your retirement account withdrawals, you can potentially minimize the taxes you'll pay on your Social Security benefits.
-
Serious Medical Diagnosis? Four Financial Steps to TakeA serious medical diagnosis calls for updates of your financial, health care and estate plans as well as open conversations with those who'll fulfill your wishes.
-
To Stay on Track for Retirement, Consider Doing ThisWriting down your retirement and income plan in an investment policy statement can help you resist letting a bear market upend your retirement.
-
How to Make Changing Interest Rates Work for Your RetirementHigher (or lower) rates can be painful in some ways and helpful in others. The key is being prepared to take advantage of the situation.
-
Within Five Years of Retirement? Five Things to Do NowIf you're retiring in the next five years, your to-do list should contain some financial planning and, according to current retirees, a few life goals, too.
-
The Home Stretch: Seven Essential Steps for Pre-RetireesThe decade before retirement is the home stretch in the race to quit work — but there are crucial financial decisions to make before you reach the finish line.
-
Three Options for Retirees With Concentrated Stock PositionsIf a significant chunk of your portfolio is tied up in a single stock, you'll need to make sure it won't disrupt your retirement and legacy goals. Here's how.
-
Four Reasons It May Be Time to Shop for New InsuranceYou may be unhappy with your insurance for any number of reasons, so once you've decided to shop, what is appropriate (or inappropriate) timing?
