The Emotion Factor

Curtailing The Leading Causes of Investors' Insomnia

By Anthony Rhodes

Imagine, if you would, the following situation: You’ve just recently created an investment portfolio. Your financial advisor has performed the proper analysis to determine your risk tolerance level. The two of you have met formally to discuss your investment strategy and through diversified investments, your money is best positioned to achieve your outlined goals. Surprisingly, over a series of a few days, the market drops by nearly 3%, and in an act of desperation you inform your advisor to liquidate all your holdings. A few weeks later, the market rebounds and your would-be investments have returned to their original levels. This embarrassing realization produces a gun shy mentality regarding your investing in the future, and as a result, you and your family miss out on a 5% upturn over the next 6 quarters.

An exaggerated story? No. A common one? Yes. Unfortunately, this emotion factor has caused many investors to panic during the markets’ turbulence, and to ultimately miss out on a subsequent upswing. Now, as emotional creatures this response is both highly predictive and typical, but as disciplined investors, it simply must be avoided. So this week, we’ll discuss some of the things that you can do to help curtail an emotional response to your investment decisions. We’ll also attempt to help you to create the mind-set necessary to both eliminate investors’ insomnia, and to develop the means to stay the course.

Kirk, Janeway...or Ahab?

The selection of your financial advisor is your first line of defense against emotional investment decisions; as our style of management often determines the comfort level of our clients. Quite honestly, the right advisor could literally be the difference between insomnia and a good night’s sleep, and for this reason, it’s extremely important to choose wisely. When selecting a financial advisor, some typical suggestions would be to ask pertinent questions to assess an individuals’ knowledge base, to discuss scenarios to determine their investment philosophy, and to find out how long they’ve been licensed. But from an emotional standpoint, you also want to find out is how compatible the two of you are, and if this person will provide a steady and consistent hand at the wheel, regardless of the markets’ movements. The receipt of this knowledge is essential to the emotional well-being of each investor, and absolutely should not be ignored. Consequentially, if you fail to enact these provisions, you may later learn that your advisor is not only ignorant, incompetent, or corrupt, but that he or she is also just as erratic as the very same markets that you are paying them to oversee.

A Matter of Time

During the formation of your investment strategy, you may be asked many different questions, none of which are more important than those which determine your time horizon. This is the period which you have allotted to achieve your investment objectives. While a short-term horizon may produce more stress because of its heightened concentration on safety and preservation, longer term investors should generally sleep better at night, because of the markets’ natural bias towards the upside. You see, good advisors understand that over time, the market has gone up, and although there’s no guarantee that it will continue to do so, history records that it’s only the short-term movements which remain unpredictable. This understanding should also assist you in controlling your emotional responses to the market. It’s important for such investors to comprehend, that once your strategy has been created and implemented, time immediately becomes your greatest ally. From a historical perspective, investors who employ longer-term investment strategies have also been rewarded for their patience; as statistics consistently show that they outperform those who attempt to time the market over the same periods. So the next time you hear those five dreadful words, “The Dow was down today,” just remember that there’s 365 days in a year, and over 3,650 in a decade, and you should sleep much better.

Stuff Happens

Sometimes, even the greatest amount of planning can be for naught, because every now and then, life throws us one of its proverbial curve balls and no preventative tactics can prove effective. This must be understood before you decide to invest. Financial advisors (despite our claims) are mere mortals, and like everyone else are subject to forces beyond our control. And although we may employ various sophisticated strategies to protect our clients’ assets, we have no crystal ball to forewarn us of the coming catastrophes which the market inevitably produces. Unfortunately, if this fact causes you to stay up at night, you probably shouldn’t be an investor. Mature individuals have come to accept this risk under the assumption that the good will outweigh the bad; which it generally does. But those who hold their advisors to the standards of oracles or prophets are simply inviting trouble. Coming to grips with this reality will also prevent you from making emotional investment decisions. The common tactic of defense is diversification; the belief that if your money is spread amongst many different investment types, the odds are that they won’t all fall at the same time. This practice within itself is not a silver bullet, but it is the best weapon in the arsenal today. With that in mind, you could take some comfort in knowing that if properly diversified and catastrophe strikes…you’re not the only one with a financial headache. But the only guaranteed way to prevent this occurrence is to be out of the market altogether, which exposes you to inflationary and other monetary risks.

The emotion factor is one of the most difficult problems to overcome as an investor, and even the most seasoned of us fall victim to it every now and then. Truly, this discipline is not learned overnight or during the course of simply reading a post, but I think it’s at least a good place to begin. Investing in the stock market has been described as an emotional roller coaster, and I do see the similarities. So I summarize this week with the same instructions which are delivered by coaster ride operators the world wide: Sit back…relax…and enjoy the ride.  

(Anthony Rhodes is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective )