Investing is emotional, even though it should not be. They impair whatever investment discipline you have, clouding better judgment.
So rather than trying to remove our emotions completely, look to harness them. This starts with acknowledging certain biases you have, many of which you probably deny. Here are 5 emotionally driven biases that can hurt you as an investor:
1) You love your company too much. Beware of owning a disproportionately high amount of company stock relative to other investments, whether through your 401(k) plan elections, restricted stock shares (RSUs) that have vested or stock options you have exercised. This may seem crazy if you work somewhere like Amazon, Google or Boeing -- companies that have thrived in recent years. And in fairness, there is some irony here in that it is likely due to company success that you own a lot of company stock in the first place. But realize your risk exposure if something bad does happen to your company's share price.
There is no specific percentage to own, as it depends on your particular situation. If you have stockpiled shares at least take inventory of all your investments and determine how comfortable you are being heavily weighted in the one company you have an irrational, positive bias towards. You may work for a great company (especially around Seattle or San Francisco) but odds are you do not know exactly how your company will perform in the future and you certainly do not know how investors will react to that performance. Find some balance and diversify, which you can do without selling all your shares or even the majority of your shares.
2) You believe the market is due to crash, fall, correct, etc... Just because you think the market cannot keep going higher means absolutely nothing. If you believe stocks are overvalued, that "another 2008 is coming" or that the market is rigged, more power to you. But those are irrational feelings. Waiting to invest based on such fear could cost you significantly in the long run by preventing you from earning what you need to achieve future financial goals.
But let's suppose you are right and it is not long before the market plunges. Let's say the market drops -10% tomorrow. Would you invest then? If not, how much further would the market have to fall beyond -10% before you would buy?
Consider what it really means if you wait for a recession, or simply a market decline of some arbitrary magnitude that you have stuck in your head but cannot clearly define. First, you have to be right about the market falling. The longer that takes, the more you miss out on potential gains. Second, you have to be right about when the market bottoms so you can pinpoint when to invest on the rebound. That bottoming process will likely take months, if not longer. Being right about both when the market falls and when it eventually recovers will be extremely difficult, especially if your decision-making stems from emotion rather than a disciplined investment process.
3) You see a falling stock and want to buy it. If an investment is consistently losing value over a period of weeks, do not try and guess when that bleeding will stop. More often than not you will find yourself buying a falling stock that subsequently falls even further.
4) You own a rising stock and want to sell it. This is less common, because a lot of investors go the other way and want to hold a rising stock they own. But more risk-averse investors will often look to sell simply because they have made money on the investment. Like the opposite of a falling stock, if a stock is rising you may not want to mess with it because rising trends usually continue higher.
5) You cling to an investment because it has special meaning. We see this among investors who hold a certain stock simply because a trusted family member owned it. This is prevalent when clients inherit shares from a family member. "Uncle Joe owned this stock and I trusted Uncle Joe, therefore I do not ever want to sell it." This type of inherent confidence is flawed and leads to misguided judgment. The world changes so much generation to generation, as does the market. Companies that were great 25 years ago may not be so today. The name of the game is making money, not to own investments that we implicitly trust based on an emotional connection.
You should have an investment plan that is free of emotional biases and focuses on what you need to earn to meet your future needs. Establish and execute an investment process, whether that involves working with a financial adviser or performing it on your own.
Brian E Betz, CFP®