Avoid the Emotional Investing Trap

We’ve all heard the phrase “No pain, no gain.” If you are a body builder or you’ve trained for a marathon, you know this saying to be true. The rest of us, however, might prefer it not to be true. The gain part sounds great, but we prefer to avoid the pain.

So how does that phrase affect us in the world of investing, especially as a retiree, and even more so when the stock market seems to be in the middle of a correction? Do we sell everything to avoid pain, do we buy more stock to capture the potential gain, or do we just ignore everything and hope for no pain and some gain?

What we’re really talking about here is risk management.

“Risk management” is a favorite buzzword for investment manager types like me. We tend to focus on technical terms in this category like asset allocation, standard deviation, Sharpe ratios, and risk mitigation—all really cool, impressive terms that mean very little to the no pain, no gain folks.

But the biggest risks that normal investors take are not always these technical market risks; they are the emotional risks. Investors become their own worst enemies in the market. They fail to realize that investing is a highly emotional activity, and emotional decisions about money are almost always wrong.

Emotional Risks Can Derail Good Investing

Let’s look at a few unconventional money risks that will undo all the cool money management ideas that your investment manager has wanted to impress you with:

The Risk of Can’t Say No.Many people face tough decisions about providing gifts to family members, continuing a lavish lifestyle when income drops, or committing to obligations that are financially out of reach. This category is emotionally charged because it involves saying no to someone or something you love. A prime example is our propensity to want to help our children. We end up enabling that person’s bad behavior and harming our own financial well-being. “No” may be the hardest and most important word to use in the English language. Use it like an airplane oxygen mask— protect yourself first so you can keep helping others.
The Risk of Faulty Assumptions. Basing major financial decisions on knowledge that we believe to be true when it’s actually false is one of our most pervasive investing errors. Faulty assumptions may come from our own misunderstandings, something we’ve heard regularly, or facts that have changed over time. For instance, it used to be commonly held that you could safely withdraw 8–10 percent per year from your portfolio for living expenses and not go broke. Now, because of changed economic conditions and extended life expectancy, this belief can prove economically fatal. When we get emotionally attached to our assumptions, we are less likely to search out the truth.
The Risk of Too Good to be True. Getting something for nothing has enormous emotional appeal. But whether the potential gain is winning the lottery or merely a free lunch, the promise rarely matches the reality. Financial products and schemes abound promising high returns with low risk. Risk-averse seniors are especially prone to being taken advantage of by these types of offers. So when you hear something that sounds too good to be true, follow these three rules: (1) If it seems to good to be true, it is. (2) If it has to be bought right now, it doesn’t. (3) If it can’t miss, it will.

What are the top risks you face in managing your retirement nest egg? Are you paying attention to the potential traps of emotional investing?

Name Your Risks

The first step to managing a risk is to identify it. Make a realistic list of everything you fear could wipe you out financially. You may be surprised at how many of these items you can control with some honesty and common sense. Being honest with yourself may cause some pain at first, but it will most likely result in some real gain. And you’ll be one step closer to winning the marathon of retirement.

About the author – Andy Raub is known as “America’s Encore Coach” because of his passion to help retirees repurpose their lives and reorganize their money. Andy is the author of the new book The Encore Curve – How to Retire with a Life Plan That Excites You and the founder of the Encore Curve Program. See how The Encore Curve process can help you clarify your life and simplify your money at EncoreCurve.com