Making Investment Decisions: Explaining the Human Side of Investing

Making Investment Decisions: Explaining the Human Side of Investing

As an investor, you may have a hamster wheel of thoughts, goals and concerns swirling through your mind from day to day:

Am I getting high enough returns? Will I be able to retire comfortably, pay for my kids’ ongoing education and care for loved ones? Am I prepared for the next market crash or market boom? Am I missing out on the latest stock tips or getting bad investment advice?

These are incredibly common and valid worries, but they can negatively impact both your investment outcomes and your peace of mind.

We typically invest money so that we can have enough later on in life to accomplish our goals and fulfill our dreams. Planning financially for the future should bring a sense of peace and security. Unfortunately, investment decisions comprise some very complex and confusing elements, which often lead to overwhelming feelings of distress and anxiety. When we’re not intimately aware of these factors and how they’re sabotaging our efforts, we can become mired in the Investors’ Dilemma.

The Investors’ Dilemma explains why many investment decisions are driven by emotional and psychological biases, ones that may actually work against your long-term financial goals. Wealth accumulation hinges on the ability to make decisions and select strategies that maximize investments year after year. However, misguided or emotion-driven actions can impede your ability to develop and maintain a prudent investment strategy.

In the interest of helping you unearth any misguided and self-defeating perspectives you may have, let’s take a closer look at the human side of investing and examine each stage of the Investors’ Dilemma. With greater awareness of these counterproductive elements, you can better position yourself to overcome them and discover more effective decision-making strategies.

 


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Fear of the Future

The cycle of the Investor’s Dilemma begins with a sense of uncertainty about the future. It’s those gnawing doubts about whether there will be enough money to maintain your standard of living and how you’ll know whether you’re choosing the best investments.

Whether you’re plagued by these or other similar questions, the bottom line is this: Practically ALL investors are afraid that they don’t know enough or haven’t saved enough to avoid becoming destitute and powerless in the future. What’s more, the media and advertisers prey upon this fear of the future in an effort to sell products.

You might not even be fully aware of the impact this fear has on your life, because it lurks under the surface in your subconscious. Still, fear is a powerful dictator of thoughts and behaviors. It’s critical for you to address this fear head on by understanding that the market isn’t something that will destroy all of your wealth, and by gaining greater insight into how much wealth markets create and how you can participate in the market.

Forecast and Predict

As a result of fear, many investors strive to accomplish the impossible: comprehending and predicting future events. You look for that crystal ball that will foretell what’s going to happen with inflation, long-term interest rates, share prices and overseas markets. You may even succeed in convincing yourself that someone else has the information, power and insight to forecast the future and alleviate your fears regarding investment decisions.

Believing that someone or something out there -- be it a broker, a high-profile money manager, a bestselling publication or even a stock-tips television show -- can actually predict and forecast the future is an enticing approach, but it’s extremely risky and can render you an innocent victim of wish fulfillment. Never lose sight of the simple fact that it’s NOT possible to predict the future and that superior performance is NOT a factor of skill.

Track-Record Investing

Sometimes investors who are convinced that the future can be foretold employ what’s called  track-record investing. This means looking to stock managers who have performed better than the market in the past, and replicating their investments in the hopes that they will continue to have superior performance in the future.

Remember, though, that there’s an important reason why most investment advertisements include the words “Past performance is no indication of future results.” It’s because you can’t rely on past performance to achieve your future financial goals. This is an ill-advised tactic that can propel you further into the clutches of the Investors’ Dilemma.

Information Overload

Prior to the Information Age, the best way to guide prudent investment decisions was to gather and leverage information. Today, however, there’s more information at our fingertips than we can plausibly digest. From Internet sources, books, newspapers and magazines to TV talk shows, advertisements and word-of-mouth experiences, there’s an overload of information that investors feel compelled to understand.

Now, instead of reducing our fears over investment decisions, this barrage of information often intensifies our doubts. Some people even worry that if they aren’t hooked into the stream of investing information 24 hours a day, they’ll miss out on some valuable piece that could mean the difference between wealth and poverty. This is a tiring and futile approach, one that can have you making poor decisions and hindering your long-term investment success.

Emotion-Based Decisions

Ultimately, there’s no way to detach from our own humanity, even in the investing world. We might prefer to think that we’re always making investment decisions based on logic, but in reality, they’re typically driven by emotions such as trust, loyalty, hope, greed and fear. The good news is that simple awareness of our emotions can help us make good decisions related to financial and investing matters.

Breaking the Rules

There are three commonly accepted rules of investing:

  1. Own equities: As these are the only investments that have historically beat inflation, most investors should allocate at least a portion of their portfolio to stocks.
  2. Diversify: Invest in a globally diversified portfolio of stocks across various countries and sectors.
  3. Rebalance: Allow investments to be sold when they are relatively high and bought when they are relatively low, even though doing so goes against our natural human instincts.

Yes, it sounds simple. And in theory, it is. However, when investors make decisions based on emotions, they often wind up breaking these rules, which can undercut their portfolios.

Performance Losses

Performance losses are failures to capture the returns an investor originally expected. Because investors so frequently break the accepted rules of investing, they do not receive the rate of return they anticipated.

By continually getting in and out of the market, you can chip away at potential returns. When this effect is compounded over a period of years, the potential for reaching financial goals is significantly decreased. Such losses create additional frustrations and fears about the future, which initiate the cycle of the Investors’ Dilemma all over again.

For most, the Investors’ Dilemma remains undefined and continues over a lifetime. The first necessary step to operating outside of this cycle is simply becoming aware of it, which you have already taken a step toward. With this awareness, you’re empowered to overcome self-defeating behaviors and approach your investment decisions with greater clarity.

To learn even more about the human side of investing and get valuable insight on how to achieve true peace of mind, access your free copy of the Investor Awareness Guide.


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About Greg Hammond, CFP®, CPA

Greg Hammond is the chief executive officer of Hammond Iles Wealth Advisors, and co-founder of Planned Giving Strategies®. Greg leads a team of professional financial advisors providing customized wealth management and investment solutions for high-net-worth individuals, families, companies, and charitable organizations across the U.S.