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Control emotions, understand psychology for smart investing, consultants say
"Don't panic," is advice heard often from financial planners and investment brokers. But don't be surprised if they start talking about psychology, too.
Control and an understanding of the psychology of investing can help people make better decisions about how to commit their money to build wealth and security in a financial market that has dramatically changed, said Kerry Johnson, a research psychologist and author.
Johnson, who will speak Oct. 29 to retirees at Lancaster-based financial planning firm Sequinox, has published several books on how psychology hinders smart investments.
"That's one of the things that affects the market right now," Johnson said.
Social economics is the study of investor behavior, such as paranoia about risk, and how it changes the markets, he said. It's also the reason that investors should consult qualified professionals to help them navigate the changing tides with a level head, he said.
"The general public is not aware of the mistakes they make every day in handling their accounts," said Joe Wirbick, president of Sequinox.
There's still volatility on Wall Street, which means people have to think more about their decisions, Wirbick said. Markets continued up steadily for more than 60 years and then crashed hard in 2007, producing the deepest recession the U.S. has seen since the Great Depression, he said.
In the wake of that wave is an environment where the rules are different, and there's a need to watch investments closely to adjust when necessary to reduce risk and prevent losses, he said. Recent signs of recovery on Wall Street can be misleading, too, he said.
"Everyone's under the assumption that everything's fine again," Wirbick said, stressing that's not the case and investors should be wary of such cavalier attitudes. "Just putting money in a 401(k) and not thinking about it for the next 40 years is no longer going to work."
That thinking is one of the many common mistakes, Johnson said. It's called "status quo bias," meaning an investor will stick with what they have in their portfolio even if it is underperforming.
That often leads to "sunk-cost fallacy," or the thought that a particular investment is too big to fail, and investors should stick with it. No one wants to cement losses, but sometimes making a change before losses get too big can open other opportunities, Johnson said.
Other psychological factors adversely affect investment decisions, too, he said. "Recency bias" means investors trust only the most recent information, disregarding compiled data about long-term performance. "Decision paralysis" is when investors are flooded with too much information, creating a fog of uncertainty.
"The most common error that people make is thinking that any two situations are the same," said Matthew Dobbie, managing partner at U Financial, based in East Pennsboro Township, Cumberland County.
The financial consulting firm was formerly Wienken & Associates Ltd. and operated under the name Executive Planning Group.
Investments should be looked at as whole, not just as retirement investments, education savings and money management, he said. It will be easier to save and invest money if clients have someone showing them how other avenues, such as debt management, cash-flow management and tax planning, can free up more money, he said.
He added "trend chasing" and "cognitive dissonance" to the list of psychological missteps. While information on the market is good, chasing the latest trends without an analysis of how it benefits your portfolio could have investors grasping at straws, he said.
"Cognitive dissonance" is when people make decisions in conflict with rational thinking, Dobbie said. It's like skipping regular dentist or doctor visits because nothing hurts. That may seem logical, but it's not going to help catch cavities or other illnesses before they do more damage, he said.
"You try to rationalize not doing something because you don't want to think about the problems," he said.
Tempering emotion is difficult, said Jeffrey Gay, a partner with Miller & Gay Investment Management, a Raymond James Financial Services branch in York. It's been more difficult over the past nine years because the markets were hit with two dramatic downturns, the first in 2001 and the second in 2007, he said.
"It's hard for many people," he said. "They watch television and get caught up in the emotions of the moment."
With so many changes in one decade, it becomes conventional wisdom to manage investments more closely, he said. That's fine as long as investors don't micromanage assets too frequently, which can be as damaging as doing nothing at all, he said.
It's better if people relax and look at investments from a long-term strategy, relying on more than just instantaneous information, consultants said.
"It really helps people come to grips with the big picture," Gay said.
[Sidebar]
"Just putting money in a 401(k) and not thinking about it for the next 40 years is no longer going to work."
Joe Wirbick, Sequinox
[Sidebar]
Psychoanalyzing investments
Most investors unknowingly fall victim to psychological pitfalls that cause them to make poor decisions about their portfolios, according to psychologists and financial planning experts.
Here are some common terms they use to describe the inner workings of the brain when dealing with investments:
Status quo bias - Picking investments, then forgetting about them or holding onto them despite poor performance
Sunk-cost fallacy - Belief that a particular investment is too big to fail; no one wants to cement losses, but sometimes a change opens better opportunities
Recency bias - Trusting only the most recent information, disregarding data about long-term performance
Decision paralysis - Flood of information creates a fog of uncertainty; investors balk about changes
Trend chasing - Chasing the latest trends without an analysis of how they would benefit a portfolio
Cognitive dissonance - Decisions in conflict with rational thinking
-Jim T. Ryan
[Author Affiliation]
BY JIM T. RYAN
jimr@journalpub.com
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