Avoid emotional trading: How to keep wealthy advisors on track
A high unemployment rate combined with stagnant wages, rising debt and geopolitical concerns are just some of the worries that have littered our headlines and challenged the confidence of investors and their advisors.
Like it or not, it's during the most trying times when advisors really earn their money as investors turn to their financial advisors for counsel and direction. This is where it gets tricky for the individual investor. Creeping into their mind is the question of whether the investment advice they're receiving is really the correct guidance. Many investors rightfully fear that their advisor may also be panicking as much as they are--a possibility that often shows up in the ill-fated attempts to exit and then re-enter the market at the right times.
If individual investors are receiving bad advice, they probably don't even know it. After all, it's human nature to act upon emotions and sometimes this leads to irrational decision making. As advisors, it is our job to educate our clients before they are confronted with these panic-stricken situations.
Let's explore three causes of irrational behavior and try to get to the root of the problem.
Instinct. Our basic instinct as human beings can be broken down into two parts: avoiding pain and pursuing pleasure. Because of this, some advisors feel pressure from their clients to sell equities during volatile and down markets. That feeling of uncertainty and the urge to seek protection is hard to control, but it is the advisor's job to make sure he does not fall victim and succumb to irrational requests from his clients.
Emotion. While closely related to instinct, emotions can also be divided into two categories: fear and greed. Both can cause an investor to make an irrational decision that may not seem imprudent at the time, but actually is. For instance, as the market continues to drop, fear takes over and immediately your first instinct is to sell. Just the opposite is greed--i.e. when the markets are rising and investments are posting record highs, the urge to dive in and grab a piece of the pie can be extremely tempting.
Perception. When discussing perception, it's important to mention hindsight as well as the human need to "follow the herd." It's completely normal to want that feeling of inclusion. After all, you don't want to be left out, pondering what could have been. It's that mentality that drives imprudent behavior. Investors always seem to want to hop on board whatever investment is hot at that moment. Right now, you are seeing that with gold, as too many people are buying in at record high prices.
When investors begin to make emotional decisions with their portfolio, they put everything at risk. It is vital that advisors take on the role of being an investor coach, stepping in to prevent irrational decision making. The best way to avoid making emotional investment decisions starts with proper education. Being prepared for the downturns and knowing how to stay disciplined and not overreact is the foundation for avoiding emotional investing.
Here are some basic strategies that coaches can use to help investors stay on track when it comes to investing:
Stay long-term focused. Investors need to see the bigger picture and remain long-term oriented. Typically, losses are more likely in the short-term, so investors who make emotional, impulsive decisions could hinder the success of their portfolio. Equities have prevailed over time and are the greatest wealth creation tool known to man.
Don't be tempted. Investors need to remember to stay disciplined and avoid playing the "tactical" game of coming in and out of the market at perceived peaks and valleys. It sounds like an easy concept, but it's a trap. Trying to time the market might sound like a good idea, but in the end such gambling and speculation will only hurt you. Market prices are random and cannot be predicted. Instead, periodically rebalance portfolios by trimming back positions that have moved above targeted allocations and use the proceeds to buy positions in areas where your target allocation has slipped.
Keep the client's heart at bay. Emotional trading can cost investors a lot in returns over a decade, so enlisting the help of a financial coach will allow an investor to stay on the right track and avoid emotional hiccups. It all starts with education. An informed client will understand the importance of investing for the long-term and avoid trying to make a quick buck.
Practice what you preach. Its one thing to say you're going to remain disciplined and focused on the long-term, but the real test is carrying out those strategies. Short-term gains can be tempting, and selling when investment prices are at their worst seems sensible, but is not. We have fired many advisors over the years that don't practice our investment philosophy with their clients. It sometimes takes a little sacrifice in the short-term, but in the long run, it's worth it.
Mark Matson is the founder and CEO of Matson Money, a Mason, Ohio-based investment advisor firm managing over $3.1 billion for investors nationwide. Matson has used his extensive experience in both financial planning for individual investors and coaching financial advisors to fuel his message of prudent investing and free market beliefs.