Emotions: The Major Cause of Investment Failure
by Archie M. Richards, Jr., CFP®
September 9, 2002
The most important cause of investment failure is not bear markets, accounting problems, or lousy stockbrokers. It's human emotions. Here are investment mistakes you may be making simply because of unhelpful emotions about money:
- Depending on where dollars come from, you treat them differently. Money earned with your own labor you spend and invest more carefully than "found" money, such as tax refunds and inheritances.
My response: A dollar's a dollar. Treat all of them the same.
- You have a savings account for emergencies, earning 1.5 percent. You also have a revolving credit card balance charging 19 percent.
Pay off the credit care with the savings. When an emergency arises, use the credit card then. You'll save money, and your credit rating will improve, cutting the rates you pay later.
- Fearful of losses, you choose low deductibles on insurance policies.
The purpose of insurance is to prevent financial disaster, not to cover small losses. Choose high deductibles and pay small losses yourself. The premium savings will outweigh the costs.
- You favor stocks and mutual funds that have performed well recently.
Last year's winner has a better-than-even chance of being this year's loser. Use index funds instead. They match markets and don't try to beat them. Buy and hold for the long term.
- In your retirement plan, you're not taking full advantage of employer matching.
Contribute enough to the plan to take advantage of all employer matching. Matched funds are just as valuable as your salary income.
- To avoid feelings of failure and the pain of regret, you avoid selling at a loss.
First, when stocks go down, it's not your fault. Second, all gains and losses are real, whether you sell or not. Third, the market couldn't care less about your costs. The only thing that counts is the future.
- For fear of losing, you avoid stocks and stick with bonds.
The historical evidence is overwhelming: Stocks outperform bonds. Invest the bulk of your money long term in domestic and foreign stocks. Treat price fluctuations, even big ones, as noise.
- You act on what you learn from TV business news and Internet chat rooms.
The primary purpose of TV business programs is to make money for the TV business program, not to make money for you. To gain listeners, they usually focus on short-term news. This induces you to trade and does your investing more harm than good. Chat rooms are generally forums for traders. Therefore, disregard financial news and avoid chat rooms. If you buy individual stocks, buy lots of them and hold for at least five years. Better yet, use asset allocation with rebalancing. (See www.archierichards.com.)
- Losses bring up feelings far more intense than those caused by gains of equal percentages. When stock prices fall substantially, you feel the market will continue down forever, and you sell in panic.
The market does not fall forever. Retain a long-term perspective. Assign a personal name to your fear of losing. (Mine is "Joey.") Converse with that person. Persuade him or her to give way to your common sense.
- When a stock you choose not to buy goes up, you think of it as a loss.
It is not a loss. It is completely irrelevant.
If you find any of these emotional matters hard to overcome, talk with a therapist. Kathleen M. Martin, CSW, of Rochester, New York, who is a therapist, provided me with characteristics of an emotionally healthy investor, as follows:
You have confidence you'll succeed.
You adopt an investment style, write it down, and stick to it.
You stay with what you know and trust your knowledge.
You're aware of your irrational thoughts and work around them.
You tolerate anxiety rather than act on it.
Short-term price fluctuations you disregard.
You learn from others but rely on your own judgment.
You know that when prices go against you, it's not your fault.
You welcome the prospect of growing rich.
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