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Investment markets aren’t nearly as volatile as the range of human emotions. That’s why the markets and the overall economy often are seemingly disconnected.
Investors can go from speculative euphoria during good times, to panicky capitulation during declines, all seemingly in a blink of an eye. Even with the normal ups and downs in the stock market, emotions are much more volatile.
Rational Decisions vs. Emotional Reality
Most economists assume that you make rational decisions based on your personal self-interest. This ignores the sometimes irrational emotions that actually form the basis of most financial decisions.
In reality, market narratives can cause you to stray from what logic would dictate. The power of individual investor sentiment can easily overwhelm economic fundamentals.
Your neighbor, colleague, or friend from the gym often matter more than actual economic inputs when you make financial choices.
Behavior Over Investment Returns
The way your long-term financial plan ultimately unfolds depends far more on your behavior than the investment returns you earn. This is a truth that many investors struggle with at times.
If you just want to focus on “outperforming” with your investment portfolio, you might really be trying to avoid the effort required for overall financial planning. Planning involves much more than your investment portfolio.
I’ve seen dozens of clients who think all their behavioral problems will simply melt away, if they can just achieve a high enough return from their investment portfolio. It usually doesn’t work that way, because while “outperformance” doesn’t persist, your emotions do.
Author Nick Murray writes, “Wealth isn’t primarily determined by investment performance, but by investor behavior.”
Planning for Uncertainty
The first step toward aligning your behavior with your personal aspirations is to focus on financial planning, not prognostication. No broker, advisor, analyst, or financial consultant can predict the future. While you might search endlessly for someone who has this ‘ability’, it simply doesn’t exist.
You probably have tried to predict various things in your life that didn’t turn out as planned. Investing is no different. You might think you know what will unfold in the future, but it’s best to plan on a wide range of possibilities. This allows you to be empowered by uncertainty instead of frozen by it.
Sure, it’s easy to say you’re going to avoid destructive financial behaviors, but in reality it’s hard to “undo” what’s hard-wired in your investment psyche. However, toxic emotional behaviors are both costly and preventable.
Some Simple Financial Advice
One of the most valuable pieces of advice we often deliver to clients is just three words: don’t do that. Good advice isn’t limited to just guiding you along the path toward your specific financial goals. It’s also concerned with helping you avoid big mistakes.
The human element is what makes the financial markets unpredictable. Emotions of the thousands of investors in the market each day are nearly impossible to forecast.
The daily financial headlines always contain hints of how volatile markets can be at times. Just remember, you can’t control the markets, but you can control your emotions.
Related: How Misinterpreting Numbers Could Be Sabotaging Your Financial Decisions