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Keeping Emotions and Investing Separate

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Written by: Bob French | McLean Asset Management 

Money is an emotional subject. It’s your life savings, your retirement, your kids’ college tuition, their inheritance. It’s important and you worry about it, and that’s completely natural. But letting those emotions taint your influencing strategy can be counterproductive. Emotional investing won’t get you where you want to go. Discipline and a systematic investment process will.

The Media wants to make money

A lot of the blame for emotional investing can be placed at the feet of the financial media. Don’t be fooled, their primary goal is not your financial success, it’s selling advertising. They sell advertising by getting viewers, and they get viewers with sensational headlines. The easiest way to do that is to make you worry that you are doing something wrong, and make you think that they can help.

Believe it or not, stress and fear do not lead to a good investment experience. Listening to the financial media leads to you whipsawing your portfolio all over the place. One month, gold is the hot sector that you need to be in, the next it’s emerging markets, and the next THE MARKET IS GOING TO CRASH SO SELL EVERYTHING AND BUY BONDS. The truth is they have no idea what is going to happen. No one does.

Investing is like Farming

Think of investing like farming. At the beginning of the season you don’t know which cornstalk is going to be the tallest, so you plant as much as you can and harvest everything. You don’t know what stock or what sector is going to perform best this year, so you diversify across everything and harvest the market returns. Some years you’ll be up, and some years you’ll be down, but if you stay the course, you’ll have a good investment experience.

Fear vs Greed

Most investors operate on two emotions: fear and greed. They’re afraid of losing money and they want to make as much money as possible, so they buy when things seem great and the market is going up, and sells when things seem bad and the market is going down. In other words, most investors buy high and sell low. This is a really great way to lose money.

Most Investors are Bad at Investing

You can see this if you look at how mutual fund investors actually perform over time. The average mutual fund investor has done a really bad job of simply capturing market returns, let alone beating the market. Dalbar studies the investment returns of mutual fund investors through time, and they really bring this home.

Investing and Emotions

 

Annualized Returns 1984-2013

The average equity mutual fund investor from 1984 – 2013 has an annualized return of 3.70% per year. Over the same period, 1984 – 2013, the S&P 500 Index had an annualized return of 11.18%. Also worth pointing, out, over the same period the one month US Treasury Bill, which most people think of as a risk free investment, had an annualized return of 3.87%. In short, the average mutual fund investor would have been better off just going to the beach and staying out of the market.

The problem is not the market. Investors could have easily captured those market returns – the S&P 500 Index had an annualized return of over 11% during that period, and index funds are cheap. The problem is the average mutual fund investor invests with their heart, not their brains. They’re either trying to outguess the market or have fallen prey to the financial media. Simply being disciplined and staying the course would have resulted in a very different investment experience.

Quick! Do Nothing!

If you base investment decisions on the cover of a magazine, you’re too late. All of the available information is already priced into the market. The movements of the stock market are based on new information, and prices move incredibly fast. This isn’t to say that the market is always right. They’re not. In fact, I would argue that the market probably misprices every single security out there. The problem is, we have no way of knowing if a security is under or over priced.

To deal with this, you need to follow a systematic investment process. Look at what you are trying to achieve with your money, and how much risk you are comfortable taking, and then set an asset allocation. Then stick to it.

Asset allocation is your best defense against emotional investing. Set your asset allocation up to achieve your goals while taking the least risk possible. Set yourself up for fewer sleepless nights, less emotional investing, and, ultimately, a better investment experience.

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