Have you ever stopped to think what motivates your investment decisions? For example, do you hold onto a particular stock because you received it as an inheritance and don’t want to sell it? When the market drops, do you find yourself automatically selling all your stocks to protect you from a potential market crash? If so, your investment decisions are based on emotions, and you aren’t buildingafinancial strategy on rational decisions. Your emotions may be getting the better of you…and draining your nest egg.
Professor Terrance Odean of the University of California is an expert in the psychology of investing, and he specializes in determining how rational investors make investment decisions.
In an interview on my radio show, “Goldstein on Gelt,” Professor Odean spoke about many of the emotions involved in investing, and how, while some people are very logical in their approach, others are governed by emotion.
“There are a lot of people who are very rationally choosing to save for retirement…. But there are also investors who churn their own accounts and run up their transactions costs, buying and selling, largely because of their emotional response to what’s going on,” said Professor Odean.
This is a phenomenon that I have seen time and time again with my clients. That’s why, when advising clients, I suggest creating a financial plan as a first step to choosing specific investments. Having a concrete guideline of your fiscal goals, and a roadmap to achieve them, helps to eliminate some of the human irrationality in investing.
Many people will also base their financial thinking on fear – either the fear of future loss or trauma from earlier losses. They also may buy a particular stock because of a past good experience. However, in the world of investing, it is always important to remember that past performance is never a guarantee of future returns.
Sometimes it’s hard to determine whether investment decisions are wholly based on logic or on emotions. For this reason, it’s worthwhile consulting with a qualified, objective investment advisor.
To find out more about the psychology of investing and how you can make rational decisions, watch a video of my interview with Professor Odean.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published April 9, 2012.