Do you have a “friend” who is intelligent, has/had a successful career, is well-spoken but keeps making emotional mistakes when it comes to money? Is this “friend” you?
Over the past thirty years, our team has served many highly intelligent people who have had great success in their particular area of expertise. There is no debate that we have a lot of smart clients. Business owners who have started successful companies. Single women who have successfully advocated to close the earning gap for females at their company. Engineers who have been responsible for helping their company find unbelievable amounts of natural gas and crude oil. Attorneys who run large law practices here in Houston and are truly helping people. And the list goes on.
With that being said, even the most accomplished people among us often make bad financial decisions because of emotional blind spots. As an interesting affirmation, my wife Emily and I have two good friends that are both doctors. The husband is an anesthesiologist and the wife is an OBGYN – can you imagine their dinner conversations? They are expecting their first daughter later this fall and both of them were recently guests at our home for dinner. The husband made the comment that they would never operate on their own child. Why? Too much emotion. Even for doctors with years of medical training, emotions can be a blind spot.
Understanding the most common emotional blind spots related to investing will help you identify a potential mistake and increase your ability to avoid it in the future.
Dumb Mistake #1: Becoming Fearful or Greedy
Warren Buffett has often said that the stock market is a constant battle between the excesses of fear and greed. It's crazy to see how panic -- or its inverse, exuberance -- can cause intelligent people to make emotional and harmful financial decisions. Remain rational when it comes to your investment portfolio. I am reminded of a quote from Lou Holtz… “Nothing is as good as it seems, and nothing is as bad as it seems. Somewhere in between lies reality.”
Dumb Mistake #2: Buy Things You Don’t Understand
If you can't explain how a company makes money to a reasonably intelligent 6th grader in under 10 seconds, you have no business investing in that company or business. If you can't understand the strategy outlined in a mutual fund prospectus, you have no business investing. Never forget that the most valuable word in your vocabulary is, "No". Do not be afraid to use it. It's better to walk away from a good investment, and still end up financially independent than it is to invest in an Enron type of investment that you do not understand.
Dumb Mistake #3: Hang On to Your Losers
We have never met the investor who has been right on 100% of their investment decisions. You need to recognize that you will not be ‘right’ on every investment decision that you make. Mistakes are inevitable. Be willing to admit you made a poor investment choice and exit that investment.
Dumb Mistake #4: Taking Too Much Risk
Statistics show that most investors tend to buy stocks when prices are high and they do not properly plan for potential losses. A major loss can be financially and also emotionally devastating. Understand your personal ‘risk budget’ related to your age and financial circumstances. Swift drops in the overall market can lead to bad decisions because of stress. If you can’t sleep well at night, you may have too much risk.
Dumb Mistake #5: Investing Using Tips From Friends Or Family
People tend to talk about their successes in life and not their failures. Personally, I rarely talk about my bad rounds of golf, I only seem to bring up the good rounds with friends. The same logic can apply to investing. We are certain your friend who always shares his stories of investment success also has stories of his bad decisions and investment failures. Friends offer great advice in a lot of different areas of life but investing is often not one of them. Be wary to trust a friend when they are giving investment advice unless they are a Certified Financial Planner TM professional or Certified Investment Management Analyst (CIMA®).
Dumb Mistake #6: Buy Too Late
We tend to really believe in a stock (or the market) when it moves higher. The problem is, the higher a stock goes, the closer it gets to its top and the farther it gets from its bottom. That means the expected reward diminishes while the risk increases. If you chase a particular stock higher you can get caught “holding the bag.”
Dumb Mistake #7: Falling In Love
The more you know about a company, the greater the chance to “fall in love” with that stock. We see a lot of clients retire with a portfolio concentrated in the company stock. Some of these retirees are emotionally attached to their company stock since they spent a majority of their career at that one company. We like to say “concentrate to accumulate and diversify to protect.”
Dumb Mistake #8: Seek Confirmation
Humans tend to look for information that supports their original claim. You buy a stock and it starts to go down, putting you in a losing position. What do most people do? They seek confirmation by looking for bits of information to justify their logic of holding on to the stock. We are heavily biased when we seek information about the stocks we own because we want to feel good about our investment decisions. Your goal should be to seek out information in an unbiased manner.
Dumb Mistake #9: Investing with a Rear View Mirror
We are often guided by our experiences – this means that we can use the past as a means to make decisions about the future. For example, an investor may remember the explosive trends that XYZ stock made a few years ago and he is constantly looking for a similar opportunity, hoping to relive what once was. The problem is that the market does not look backward, it is always looking to the future.
Takeaway
You need a written financial plan custom-tailored to your particular situation that provides comfort, confidence and clarity about your financial future. We call this our Live Well Plan. This plan is designed to help you take the emotion out of investing by developing a Family Index Number which determines the rate of return needed to help meet your retirement goals.
You need a repeatable investment process to preserve investment capital during the next economic downturn.
You need a portfolio designed to generate an increasing amount of reoccurring income in retirement.
You have worked too hard and too long to leave your retirement planning to chance!
Any opinions are those of the financial advisor and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Past performance may not be indicative of future results.