Emotional Investing: Keeping Your Emotions from Dictating Your Financial Future
You've probably heard of emotional eating, but financial advisor Matthew T. Shafer says emotional investing is a problem that needs to be recognized society-wide, especially since the economy has been in such sharp focus this past half decade.
"The words of an experienced mentor have proven to be spot on throughout my career; he said that no matter how smart they are, most people don't know what to do with their money," says Shafer, named one of the top 1,000 financial advisors in the U.S. by Barron's Magazine.
"It wasn't that people were ignorant, and it wasn't that they were incapable of analyzing investment opportunities. The challenge occurred when emotion clouded their judgment."
People become too optimistic and enthusiastic when their investments are on the rise, and too fearful and skeptical when they see a decline, he says. This holds true for all income levels, says Shafer, author of The Future of Your Wealth.
He offers tips for avoiding what he calls the No.1 detriment to your financial well-being.
- Create a buffer of expertise. It's impossible to completely separate your emotions from your finances. But you can create distance between them by putting experts in the middle. "During the financial crisis, I had a number of clients who would have made painful mistakes if I hadn't helped them manage their emotions," he says.
- Sometimes, you have to do the tough thing. Financial advisors, too, experience emotional responses to market crashes and other startling events. That's why it's tough to exercise discipline, and caution against over investing assets that are hot. Why? For the same reason buying a home during the peak of the real estate market turned out to be a poor decision - because bubbles burst. Similarly, after housing prices have crashed - that's the best time to invest in property.
- Build your knowledge; it breeds confidence and prevents panic. "The more I can educate clients about how markets work, and the cycles that they go through, and what is going on now, the more confidence I believe those clients will have in their investment strategy," says Shafer. On the other side of the spectrum, people tend to get more emotional about things they don't completely understand "I think that's basic human nature," he says.
- Don't let malaise dominate your future; embrace optimism where you can. Today, I believe the number one emotion that clouds the future is pessimism. Even though we're coming out of the Great Recession and things are starting to improve, a lot of people are still scarred by their experiences of the past decade, fearful that our world has permanently changed and we face insurmountable problems. Excessive pessimism is just as detrimental to your future wealth as too much optimism; balance and objectivity based on solid information will serve you best.
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