Tuning Out the Noise
- Despite the sheer volume of investment information available these days, we all too often base our financial decisions on emotion rather than information.
- Investment decisions made based on emotions often result in subpar returns or a loss of wealth.
- By applying a handful of sound investing concepts to your portfolio, you can remove the emotion from your investment decisions.
You are inundated with information from every direction these days. As the head of a successful family who wants to make smart decisions about your investments, you know about the sheer volume of financial data and commentary bombarding you from the Internet, television, newspapers and magazines. It can be extremely difficult—seemingly impossible, even—to sift out what is genuinely useful and to leave the rest. It all begins to sound like noise.
Unfortunately, it’s easy to get caught up in all that noise, because we are “wired wrong.” Instead of using the information to make decisions thoughtfully and logically, we get drawn into the emotion generated by the noise. And when people begin to base their financial decisions on their emotions, we believe that they very often make mistakes. They chase hot stocks and market sectors while ignoring investments that are undervalued and poised to rise. They forget about risk and volatility. As a result, they often lose money and fail to preserve their wealth, or they earn subpar returns that fail to help them achieve their financial goals.
To help you understand how emotion can lead you to make investing mistakes, let’s look for a moment at what might happen when you hear about a stock.
If you are like many investors, you do not buy the stock right away. You may have had the experience of losing money on an investment—an experience you did not enjoy—so you do not rush out and buy the stock immediately. Instead, you decide to follow it for a while to see where it goes. Sure enough, it starts to trend upward.
You follow the stock for a while as it rises. What’s your emotion? Confidence. You hope that this might be the one investment that makes you a lot of money. You probably will do a little research on the Internet and even call a stockbroker. Let’s assume that it continues its upward trend. A new emotion kicks in as you begin to believe that this just might be the one. This new emotion? Greed. You decide to buy the stock that day.
You already know what happens next. As soon as you buy the stock, it starts to drop. Everyone has had this experience. You are flooded with new emotions: fear and regret. You are afraid that you have made a terrible mistake. You no longer care about making a profit. You promise yourself that if the stock just goes back up to where you bought it, you will never do this again. You don’t want to have to tell your spouse or partner about it. You don’t care about making money on the stock anymore; you just want out now.
Now let’s say the stock continues to drop. Yet another emotion—panic—takes over. In your panicked state, you cannot help yourself: You sell the stock at a huge loss. And what happens next? New information comes out and the stock races to an all-time high. (See the illustration below.)
The Emotional Curve of Investing That Happens All Too Often
Emotions are powerful forces that sometimes cause you to do exactly the opposite of what you should do—in this case, buying high and selling low. If you were to do that over a long period of time, you would seriously damage not just your portfolio but, more important, the realization of your financial goals.
The good news is that there is an alternative to noise-based investing. By applying a handful of sound investing concepts to your portfolio, you can tune out the noise and remove the emotion from your investment decisions. These success drivers will help empower you as you move toward achieving consistent long-term success in growing and preserving your wealth. We set out each of those concepts in the following articles:
- Success Driver One: Create a Road Map
- Success Driver Two: Leverage Diversification to Reduce Risk
- Success Driver Three: Seek Lower Volatility to Enhance Returns
- Success Driver Four: Diversify Globally to Enhance Returns and Reduce Risk
- Success Driver Five: Document Your Investment Plan
- Success Driver Six: Track Your Progress