Client Center

Emotional Investing: How to Avoid Costly Mistakes

Posted on December 7, 2011

Money and emotions are not easy to separate, but to make smart financial decisions, you need to detach momentarily. We work hard to earn and preserve our assets, and it can be difficult to sit back and watch the market mold and rearrange them. Fortunately, you don’t have to do it alone. That’s where your CPA comes in.

A CPA’s job is partially about assuaging the emotions that can lead to rash decisions. According to a recent study, the average mutual fund posted an 11.9% rate of return, as opposed to 3.9% for the average individual investor in a similar market.

What accounts for the discrepancy?

The individual investor is more prone to emotional decisions and abrupt moves with his/her portfolio and is more likely to succumb to the volatility of the market.

Smart investments aren’t just about making the right moves; they’re also about having self-control and refraining from making an emotionally driven mistake. A financial planner can help you make logical decisions and ensure your financial security.

In 1998, Ryan Leaf was the number two NFL draft pick behind Peyton Manning. Both players had brilliant college careers and received an enormous amount of hype, leading fans and media to speculate who would be the greater quarterback. Manning went on to break dozens of NFL records; Leaf was released after fifteen months, fourteen touchdowns and 36 interceptions. A concenus of football experts opinioned that the biggest difference between Manning and Leaf were there emotional behavior Manning knew how to control his; Leaf did not.

Investing is similarly volatile. Emotional decisions based on hyped investment opportunities can lead to busts on a Leaf-like scale. However, there are steps you can take to help remove the emotional element and ensure a level-headed approach to financial planning.

Proper Allocation – Dividing your assets among stocks, bonds, and cash investments can help you to manage risk while not sacrificing too much reward potential. When developing an allocation strategy, it is important to keep in mind the time span of your investment goals, and the amount of risk you are willing to take on.

Diversify – Allocating your funds appropriately removes some of the risk of emotional investing. However, the shrewd investor must also diversify among these asset categories. If a client invests in several sectors of the banking industry, his portfolio is not entirely diversified. In order to truly mitigate risk, investments must be spread among several different industries.

Avoid Excessive Micromanagement – Sometimes it’s better to just leave your portfolio alone (temporarily, of course!) When you make a habit of buying into the hype and selling from the panic, you’re bound to end up in a cycle of stress and low returns. Feeling anxious? Talk to your CPA; they can help you to see the bigger picture.