Are you a resilient investor? Do you take market volatility in stride, or are you tempted to react when things get challenging?
Our financial advisors have learned first-hand that resilient Investors do these three things before making any important money decision:
- Check assumptions
- Check thinking
- Check emotions
Most people aren’t rational when it comes to money. The field of Behavioral Finance provides insights into why this is true. From time to time, we all make thinking mistakes. Researchers describe these mistakes as biases, which fall into three broad categories:
- Belief perseverance biases
- Information processing biases
- Emotional biases
Let’s imagine how this might work using today’s headlines. Inflation is at a 40-year high. Gas prices are increasing daily. There is a war in Ukraine. The stock market is in a slump. We see these news stories unfold, day after day, and we worry about what they all mean. We see our investments declining, our retirement funds shrinking, and we are tempted to do something…anything…to stop the loss. To stop the pain.
So, we react. We sell. We may feel better for the moment, but when it comes to overall wealth management, we may regret that decision in the long run. History shows us why.
This blue line is tracking the return of the stock market. We know it goes up and down. But from a distance, we see the trend seems to be up over the long run. The headlines help tell the story: The dot com bubble, the dot com burst, 9-11, the subprime mortgage crisis, the Great Recession, Brexit, the fiscal cliff, and Covid-19.
Hindsight is 20/20. If you knew then what we can see now, what would you have done? You would have stayed the course. You would have invested more if you’d had it. But when you’re in the moment, you don’t know, and it feels like something you’ve never seen before. And you react–maybe not at first, but these things tend to take time to work out. The continuous grind of the negative news cycle, along with the declining numbers month after month, all take their toll. Here’s the evidence.
Green bars show the net amount of money going into all stock mutual funds. Red bars show the net amount of money coming out of all stock mutual funds.
Notice how the money pours in as the market goes up, increasing at market peaks.
Now, notice how money gets pulled back out as the market is going down, increasing at market bottoms.
What’s the first rule of investing? Buy low, sell high. But here, it looks like a lot of investors are doing the exact opposite. Why is that? It could these biases at work.
So, what should you do to avoid making these thinking mistakes? First, check your assumptions. Confirmation bias happens when we reach a conclusion and then look for information to support that decision while ignoring anything contrary. Instead, look for contrary information, and then weigh it together with supporting information.
Second, check your thinking. Are you following a thorough process? Recency bias is the tendency to put too much weight on recent events as a shortcut to a quick decision. Following a disciplined process will ensure you check all the right boxes.
Third, check your emotions. The loss aversion bias is a very powerful emotional bias. Look, Nobody likes to get hurt. Nobody likes to lose money. But, know that emotions are like waves crashing on the beach. In time, the waves will subside, as do feelings. Make sure you are clear-headed when making money decisions.
So, next time you have a big money decision in front of you, be resilient: Check your assumptions, check your thinking, and check your emotions. Doing so may just help you avoid a big mistake.
Clark Brown is a financial advisor in Athens, GA. Whether you need assistance with wealth management, retirement planning, or anything in between, Clark and our financial advisors at Elevate Wealth can help. Contact us today for a free consultation!