Separating Emotions and Investments

I was watching the St. Louis Blues game a few nights ago. They have been playing great lately, and the games have been a lot of fun to watch. They were playing the New Jersey Devils on Tuesday and dominated from the start of the game. The score was 6-1 at the end of the 2nd period. This was when I decided that it was time to turn the game off.

Here’s my reasoning.

First, it was getting close to my bedtime. More importantly, the chance of enjoyment was significantly less than the chance of disappointment. I wouldn’t gain much excitement if the Blues score more goals. However, it the Devils come back and make it a close game or somehow win, my frustration levels would skyrocket. This wasn’t a playoff game or anything of significant importance. The risk of pain was much higher than the reward of enjoyment.

This is similar to how you should view your investment accounts. Many people are constantly following their 401(k), IRA, and brokerage account balances. They log in every day to see what the market is doing. Some article in the news about a possible recession will send them into a panic and they need to check their investments and see if they should do something to avoid losing all their money.

Why is this a bad thing?

Over-analyzing your accounts leads to emotional decision making. Human emotions getting involved in investment decisions leads to poor results. Countless studies have shown that individual investors buy when the market is high and sell when the market is low. It’s human nature to want to get out of the market when it feels like the market will go down forever.

Don’t believe me? Here are a couple examples. Do you remember the dot-com bubble? Internet stocks roared through the late 90’s and into 2000. Investors couldn’t lose money! The bubble finally burst in March of 2000 and markets declined until October of 2002. What period had the highest amount of new investments? The first quarter of 2000. The Great Recession in 2008 is another perfect example. The stock market was slowly declining from October of 2007 through September of 2008. It then declined sharply from September 15, 2008 and finally hit it’s low in March of 2009. When did investors withdraw the most money? October of 2008.

Buying high in excitement and selling low in fear of losing everything. Human emotions are terrible at investing. Here are some things you can do to keep your emotions under control.

· Set a plan – Your plan should consist of an asset allocation strategy. This strategy should not change when the market fluctuates. It should only change when your life changes and requires you to reevaluate.

· Don’t have money in the market that you need soon – The general rule of thumb is that you shouldn’t have any money in the stock market that you need to use in the next 3-5 years. This may force you to withdraw money at the wrong time when the market is down.

· Stop looking at your balance so much – Give yourself an emotional break.

· Increase your contribution rate – Are you seeing too much scary news about a possible recession? Log in to your accounts and increase the amount you are contributing. This will allow you to buy more at lower prices if the market does go down farther.

·  Set a rebalance schedule – Rebalancing will allow you to keep your actual asset allocation in line with your plan. A set time frame will allow you to keep the emotions out of it.

Just like watching sports, sometimes it’s easier for your mental state to stop watching your investments. Although, I should mention that every Mizzou game starts with a higher risk of pain than enjoyment so I must admit that I’m not perfect when it comes to my sports watching logic. How can you tell the people who check their accounts too much? Think back to Christmas. The market had one of the worst Decembers in history and the bottom was Christmas Eve. I’m guessing at least one person in the family couldn’t stop talking about markets and a possible recession. Hopefully you were the one reassuring them that markets fluctuate and it’s normal. Now you can send them this post and tell them that life is much easier when you keep your emotions out of your investment strategy!

Mike Zeiter, CPA/PFS