If you look at your social media feeds and the news over the last three months, it seems that everyone is now a financial expert.
While that’s not true, of course, there are some new ways to think about the study of finance and investing. Called behavioral finance, this new field explains how humans let emotional and cognitive biases — the way we are wired to see the world — affect our decision making when it comes to money. In the spirit of Financial Literacy Month (April), let’s look at an area that can have a great impact on your financial future.
Emotional and cognitive biases are at play all the time, but become most detrimental to your future during extreme market environments, either during massive market sell-offs or periods of mouthwatering returns. In fact, these biases are the primary cause for these extreme market environments in the first place.
To see the effects of these behavior biases in play, you only have had to pay attention to what was happening in the markets in the last 13 or 14 months.
You already know the past year has been one for the record books. We went from the fastest-ever 35% decline in the S&P 500 to one of the best 12-month returns in history. This recovery in stocks has been supported by a robust and powerful economic expansion.
The past few weeks have seen one blockbuster economic report after another. From the 916,000 jobs that were added in March to retail sales jumping 9.8% month-over-month, these are some of the best economic numbers we could see in a lifetime.
With eyepopping numbers like these, it is easy to let your emotions get the best of you and stray from a well thought-out, sensible financial plan.
What Not to Do
Although it may be tempting, avoid making rash investment decisions based on what you see in the news or hear from friends and family.
For example, you might turn on your favorite news channel and hear that the markets are up 50% over the last year. Your first reaction may be to sell everything, sensing that this has been a good run, but the markets are due for a pull back.
Or perhaps you might have the opposite idea, feeling that with all this positive news, things are just getting started. Your gut reaction is to protect your assets right now or try to get a piece of those great returns before it’s too late.
Both reactions might seem to be in your best interest, when in reality both are moving you away from your sound financial plan, which was set up to give you the best shot of success in the first place.
What to Do Instead
- Talk to your Advisor
For most of us, planning for your future spending and managing investments tends to be dictated by our emotions more than logic or reason. For good reason: Money represents all of our hopes and dreams, as well as our fears. Your Advisor will be able to act as an educated, unbiased third party to guide you through investment decisions and other aspects of your financial life.
- Think Long-Term
It is also vital that you think long-term when making decisions, rather than following trends that won’t help you in the future.
- Know Yourself
Being self-aware is an important step in avoiding behavioral biases when it comes to investing. Know your level of risk tolerance and allow that information to help determine your asset allocation strategy. Doing that should help alleviate some worry regarding your investments and reduce the urge to make choices impulsively based on the news of the day.
Acknowledging and controlling your behavioral biases can help you feel confident in your investment decisions and everyday spending choices. Working with your Telarray Advisor allows an objective third-party to offer educated guidance and direction — without emotional bias.