Do you want to know the biggest threat to investors trying to reach a comfortable retirement? It's not economic downturns or rising interest rates. Nor is it student loans or rising medical costs. In fact, an investor often has total control over their biggest obstacle to reaching retirement.
That's because an investor's greatest enemy is always himself or herself.
When I teach classes, I tell my graduate students this: If I could sum up the world of investing in two quick and memorable bullet points, they'd be:
- Keep your fees low.
- Don't do anything dumb.
It sounds pretty simple, but you'd be surprised at how often investors do permanent harm to themselves simply by allowing their emotions to guide their investing. Let's talk about why emotional investing is so problematic for investors, and the strategies that can allow investors to succeed over the long term.
Two Different Cycles
Emotional investing is so prevalent because we (as humans) are hard-wired that way. It's in our DNA to get excited about investing as the market rises and to get pessimistic about investing as the market falls. This pretty much runs contrary to the basic rule of investing: Buy low and sell high. Check out the chart below, courtesy of The Big Picture blog:
As you can see, investors' emotional cycles essentially move inversely to market cycles. Human emotions lead investors to feel negatively about investing just before the market picks back up again. Not only is this a missed opportunity for investors to take advantage of mispriced stocks on the marketplace, but getting out of the market at its low points harms investors when they “sell low” and don't see returns on their investments.
Negative and positive emotions are to blame here. While negative emotions prevent us from taking advantage of the market, positive ones make us overly optimistic; we forget to do things like keep our fees low, think about our risk tolerance or keep an eye on diversification.
So how can an investor avoid the pitfalls of emotional investing?
A Cool Head
One of the greatest advantages of having a financial advisor is that he or she will always serve as your accountability partner when the going gets rough. Right when you're about to make investing decisions and leap off that metaphorical cliff, an advisor will pull you back from the precipice and prevent you from snatching defeat from the jaws of victory. When investors are the weakest, a good advisor will offer support for sticking to your initial plan, while many investors who go it alone fall prey to these bad behaviors because their emotional instincts are too strong to ignore.
Financial advisors are able to offer this support largely because they have a historical perspective of what has happened in the market over many years. Day to day, the markets can be very volatile. Over the long term, however, there are distinct trends and cycles. Preventing an investor from getting caught up in looking at the short term and pointing them toward what the market trends over time have been is one of the most important jobs of any advisor.
In essence, a great financial advisor will help you keep your fees low and prevent you from becoming your own worst enemy—someone who will coach you through rules #1 and #2. It's that simple (but that doesn't mean it's easy!).
Stick to Your Plan
As our Two West philosophy states, “Two people working together have a better chance of reaching their destination than they do going it alone.” As advisors, that means we're keeping the people we work with focused on where the path leads, and not overly concerned with each turn along the way. And when the weather ahead looks stormy, we're there to offer an umbrella and a raincoat, and show them how they can navigate that path just the same.
Keep your emotions out of your investing decisions (and use someone to keep you accountable), and you'll be able to navigate your path just fine.
Vern Cushenbery is a partner and CIO of Two West Companies, and a great lover of graphs, charts and looking at long-term trends in the market. He's very much looking forward to hanging out with his daughters on summer break this year (even if they aren't as thrilled to be hanging out with him).