The human brain uses a system of shortcuts to analyze and respond to potential threats. Thousands of years ago, this system helped us deal with threats like lions or poisonous berries.
Today, however, these time-saving shortcuts can sometimes get in the way of making better long-term decisions. When something knocks our stomach down—like a 15% correction in the stock market—the survival instinct buried deep in our brains is triggered and forces us to act to avoid the thing we fear most. Huh.
In this article we explain three very human ways of thinking that can sabotage your portfolio. In each instance, ask yourself if you’ve ever wondered. If so, we’ll explain what might happen at work and suggest ways to retrain your thinking.
1. ‘I will sell this stock if I can break it’
Let’s say you have a goal of buying a home in 10 years and you invest $10,000 in a stock to help you reach that goal. Let’s assume the stock had performed well for 18 months, but has since fallen to $7,500. What would you do? Sell? Or remain under the impression that what goes down must come up?
Chances are you have chosen the correct answer: Sell to avoid further losses. Expecting that the stock will recover enough to break out is usually based on “anchoring bias”. Anchoring simply means that we are most affected by our first impression. The potential growth that you initially saw in the stock is very difficult to reconcile with the idea that it could be losing money.
A second bias is the “fad-cost effect”. This bias prevents us from forgetting the money we have already spent. We feel like we have to wait until the investment pays off instead of recognizing a lost opportunity by sticking with a loser.
To correct anchoring bias, you need to remind yourself that the purchase price of a stock is not the same as its value. And as far as avoiding the sinking-cost effect is concerned, you need to be prepared to give up on an investment that isn’t performing well.
2. ‘I will focus on my retirement once I save more’
A common excuse for not saving for retirement is, “I don’t have money.” Most of us have great difficulty making plans for the distant future. This feeling of “it’ll be okay, I’ll deal with it later” can really sabotage your goals.
Our brains prefer the status quo, a bias that stems from our need for normalcy. We like what we know, even if what we know isn’t all that great. Another bias is decision fatigue. We are faced with making so many decisions during a day or week that our decision making energy is exhausted.
Will your bank savings be enough to take you through retirement, or do you need a more comprehensive plan? You need to consider all the investment options on the table. Schedule time to confirm that your investments are performing as expected.
3. ‘I’m doing fine so far. Why do I need a consultant?’
How would you rate your driving abilities? Top third, middle third or bottom third among all drivers? A 2018 Psychology Today research study on overconfidence showed that 90% of people place themselves in the top third of drivers and that very few place themselves below average – even though in fact one-third equally each. fall into the category.
If you are managing your own investments, chances are you are doing an average job, making some good and bad trades. But if you’re overconfident, you may think you’re doing a better job of trading than you actually are.
Without thinking about it, we’re pretty good at taking our driving (or investing) experience and creating a compelling story to convince ourselves that we’re above average. Overconfidence is a close analog of bias: self-attribution. Think about a time you played cards or fantasy football. When we win, it’s because we’re skilled competitors, but when we lose, it’s just bad luck.
Being humble is essential to balancing overconfidence and self-attention. We don’t know what we don’t know. Unlike the townspeople of Lake Wobegon, we can’t all be above average.
If you are your own worst enemy when it comes to managing your money, here are three steps that can help you put yourself on a strong financial footing.
Set specific goals. It’s not enough to say that you don’t want to run out of money. Where you want to live, how to spend your time, what you need to provide for other family members, and what your spouse or partner wants to achieve in life are all important things to think about and aim for. is to be determined.
Make a long-term plan. A written plan will tell you what income your assets will need to generate, allowing you to properly calibrate your risk. An experienced financial advisor can help with this.
Implement and refine the plan. Just landed a new job? getting married? starting a Business? Selling a Business? Whenever a major life change occurs, take the time to revisit your financial plan and make sure it is still relevant and accurately reflects your wishes.
The most important thing is to make sure that you are comfortable with the risk you are taking, and that your decisions are based on your long-term goals, not today’s market volatility.
If you’re interested in learning more about this topic, please call Wealth Enhancement Group at 1-888-819-5520 and request a copy of our e-book, Can You Reduce Your Investing Success? are doing?
The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Bruce Helmer and Peg Webb are financial advisors at Wealth Enhancement Group and co-hosts “Your Money” on Sunday Mornings on KLKS 100.1 FM. Email Bruce and Pegg at firstname.lastname@example.org. Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, LLC, a Registered Investment Advisor. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.