Emotions Will Inevitably Find Their Way Into Your Investment Strategy

Accidental FIRE hits on the intersection of emotion and investing and urges us all to eliminate emotion from our investment strategy. I’ve heard this same advice from many financial advisors and investment gurus over the years and it’s always given with heads and hearts in the right place, but  I don’t believe it to be effective.

The blogger provides example of market losses and points out that most of the best days for equity markets over the past 20 years have come within a month of one of the worst days. Accidental FIRE recommends distancing oneself from emotion – but that’s not so easy. Human beings are emotional creatures.

More than downturns

Let’s be clear, investor behavior during market downturns is among the most wealth-erosive elements of an individual’s financial life, if not the primary cause of loss of capital. But there are other negative emotional reactions to finances.

There’s the fear of getting started, especially for young savers – can we adjust our lifestyles so that we have enough to make ends meet and we’re saving efficiently for our financial goals? A lot of people my age and younger are frozen when they should be saving already. My solution to the fear of getting started is gradual, escalating savings.

There’s the fear of missing out – when the market drops, do you go on a buying spree or do you bargain hunt? Are you an income-oriented investor who constantly feels distracted by other investors’ successes in high-flying technology stocks? My solution to the fear of missing out is to carve out a very small portion of one’s investment portfolio for speculation. This is akin to budgeting a few dollars each week to buy a couple of plays in the lottery, but if it keeps an investor from putting all of their money into get-rich-quick-dream speculation versus building wealth slowly, then it’s an effective intervention.

There are other emotional and behavioral biases that impact our investing choices. Optimism bias makes it difficult for us to envision how our choices  could go wrong in the future. Positivity bias makes us more likely to share – and too listen to – investing successes than investing failures. Being a market participant means running unshielded and unarmored across a minefield of your own behavioral and intellectual shortcomings.

Try passive

One of the best interventions for emotional investors is passive investing – buying the market/indexes at an allocation that reflects current financial market conditions, and only rebalancing periodically to stay on a target market allocation

For passive investors, keeping emotion out of investment decisions is quite easy. Contributions and allocations are automated, rebalancing is scheduled and systematic and there is no opportunity for quick, irrational or emotional decisions to pollute the strategy. Most of us should probably be passive investors. For the most part, I am a passive investor. Active investors are more likely to leave open the potential for emotional decision making. They’re  more likely to try to get tactical with their allocations, and more often than not when individual investors try to get tactical, they fail.

Deal with your emotions

My point is that money is emotional. Finances are emotional. Investing is a behavioral choice, and no matter how much of an emotionless automaton you aspire to be, emotions are going to creep into your investment behaviors. Asking a living human being to reject their  emotions or to be emotionless is like asking someone to stop breathing. You’re going to be emotional, wealth is the vehicle that  can take you where you want to go in life so your feelings and behaviors will play a large role in all of the choices you make around that wealth.

Telling someone not to be emotional with their money ignores human nature entirely.

Instead, we should be aware of how our emotions come into play when we make money choices. My favorite  emotional/behavioral intervention is patience. Think you have a good idea? Great! Sleep on it. There’s nothing like time to help us re-think and re-imagine our choices.

While waiting to make a final decision sounds well and good, it can be unrealistic – investing opportunities sometimes come in short windows of time where we must seize the moment or lose the chance. If you really feel like this is the case with a potential choice, keep a trusted, educated and reasonable third party accessible in person, by phone, text, or online chat. The  financial services industry will tell you this should be a financial advisor, but it could be a qualified spouse, friend or relative who you trust. Run your ideas by them first.

But for pity’s sake, don’t pretend like you’re going to be unemotional and that you’re immune from behavioral biases and rash decisions, because you most likely aren’t. Don’t aspire to shed yourselves of emotions, because they can and do serve you well. They make you human, and they provide meaningful context for your financial lives. Instead, live a financial life where you’re aware of your emotions and can properly incorporate them into a decision-making process. You’ll be a better person – and a better investor – for it.