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Emotions: The Achilles’ Heel of Financial Investing

Posted by Sean Linder on Thu, Feb 11, 2016

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climbing_growing_stairs-1.jpgBuy low and sell high – the rational investment strategy. Sounds simple and straight forward in theory, but throw in human emotions and this once simple adage becomes difficult to implement in reality.

There are many theories behind behavioral finance and what drives investor’s decisions, but one observation has become clear: on average, individual investors tend to make irrational investment decisions.

A recent study by financial services market research firm DALBAR concluded that between 1995 and 2014, individual investors had the second worst 20-year annualized return out of just about every asset class at 2.5%, inching by the worst performer, inflation, at 2.4%. During this same time period, a portfolio comprised of 60% stocks and 40% bonds would have returned 8.7%; a significant underperformance by most standards.

The confident and positive emotions most investors feel when the market is rising typically leads to increasing risk and potentially purchasing securities that have over appreciated. While the fear of losses during volatile markets drives the avoidance of risk, when perhaps the opportunity for greater returns may be highest.

These emotions can cause counterintuitive reactions that overtake our rational thinking, leading to under performance and potentially permanent impairment to an individual’s financial goals and standard of living.

Know Thy Self

In order to combat emotional headwinds, investors first need to have an understanding of themselves and their financial needs. What is your ability and willingness to take risk?

Your ability is based on your financial needs now and in the future. A retiree looking for cash flow today has a much different risk profile than a 22-year-old just starting their career.

Your willingness is your own personal preference for risk. For the average investor, the pain from loss outweighs the joy of gains by approximately 4-to-1. What level of volatility are you comfortable with?

Patience is a Virtue

Over the short term, the stock market is a reflection of investor sentiment. Which means it’s unpredictable. It can go up, down, and sideways in any given day, week, month, or year.

Over the long term however, it’s a reflection of a company’s ability to grow earnings, increase cash flow, and return capital to shareholders, which has an upward bias. Over the last 87 years (1928-2015), 73% of the time the markets ended positive for the year, returning just over 9% per year annualized to capital fully invested during the entire time period, based on data provided by Bloomberg.

In other words, it pays to have patience.

Remember, emotions are the Achilles’ heel to investing. They will force irrational decisions which can ultimately lead to permanent impairment of your financial goals. Talk with a financial professional to help define and implement an investment strategy designed specifically for your own unique financial needs.

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”  – Sir John Templeton

Looking for more retirement or general savings advice? Contact me at Concannon Wealth Management at  610-814-2474 or slinder@cwm.us.com.

Topics: Individual tax planning

Concannon Miller’s unique, holistic and intimate approach to financial health sets us apart from smaller CPA firms with more limited resources as well as mega firms where mid-sized clients struggle for attention. Contact us here to talk about improving your business.

This communication is designed to provide accurate and authoritative information in regard to the subject matter covered at the time it was published. However, the general information herein is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purposes of avoiding tax penalties.

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