Most everyone tells you that in order to make the best retirement investments, you have to ignore your emotions. They trot out fancy charts and graphs to prove their point.
And they’d be right. As investors, we would be far better off if we ignored our emotions. There is only one problem with that idea.
If you’re human, you can’t do it.
Consider the graphic to the right.
It shows that investors earn roughly half what their investments make. Why? Because people react emotionally. We get frightened, so we sell. We get greedy, so we buy.
All this emotional investing costs us a fortune. Wait…didn’t I just contradict myself?
If investing emotionally is so expensive, why am I telling you to embrace your emotions? Have I finally lost my mind as my wife and kids keep suggesting I have? No. That’s not the reason at all.
I suggest that you embrace your emotions when you invest because you simply can’t do otherwise. There is a huge difference between reacting emotionally and using your emotions when you invest.
Know Your Emotions Before You Invest
What I’m saying is that if you consider your emotions before you invest, you’ll be less likely to react emotionally when things get sticky.
Ignoring your emotions is like trying to keep a lid on the top of a boiling pot. Sooner or later, the thing is going to blow. That, in a nutshell, explains the graphic above. I’m going to propose a solution, but first I’d like to play make-believe with you.
For a moment, make believe that you are a financial adviser. Your client, Denise (real person, different name), comes to you with a dilemma. She’s 57 years old and a single woman. She has a grown son but she supports him every now and then. Denise is only a few years away from retirement. She invested her $300,000 for retirement in the market and now it’s become $171,000. Look at the chart below and just imagine how she felt each month as her account value dropped. (Maybe it isn’t that hard for you to imagine…)
Denise comes to you for advice. She tells you that she can’t tolerate any more market losses and has started checking online savings accounts. At the same time, she tells you that she’s afraid of pulling all her money out and missing the market recovery.
You have three choices:
a. Tell her to ignore the market. You’ve got the graphs to prove why. Just increase the Zoloft.
b. Move everything to the online savings accounts – just like her friend Tom told her to do.
c. Compromise by putting half the money in short-term bonds and keeping the other half in the market.
What would you tell her to do? Why? How would you explain it to her? Do you have a fourth option for Denise? You may already know what my opinion is, but I’ll share it with you anyway next Tuesday.