How do emotions impact investment decisions?
The concepts we’re about to cover may change the choices you give your employees to help them achieve a healthier financial result for their future.
But before we get into that, if you are interested in learning about our process to structure a successful retirement program, click here for a free copy of our book “The Quintessential 401(k).”
Now, back to our topic. When it comes to investing, there are three main emotions that can negatively impact your employees’ results.
The first is investing overconfidence. Studies show that investors believe they know more about investing than they truly do. This overconfidence may lead investors to believe that the success they’ve achieved in the past is due solely to their decisions.
The second is availability bias. Investors extend their view of the world markets too far into the future and let their limited knowledge and personal bias influence their decisions. As an example, investors in the mid-2000s were convinced the equity markets would only rise. Then, there was the credit crisis of 2008 and the collapse of the financial markets. Most accounts were down by 40% or more.
Investors who sold and stayed in cash for years before re-entering the market missed out on the returns in 2009 and 2010.
“If you’re not willing to take the appropriate amount of risk, you might need to save 3 to 5 times as much as the next person.”
The third emotion that influences investors is loss aversion. Loss aversion refers to people’s tendency to avoid losses to acquire equivalent gains. The pain of a $500 loss is much greater than the satisfaction of a $500 gain. People will overstepping their boundaries in hopes of avoiding the loss.
As we tell participants all the time: It is possible to be too conservative. If you’re not willing to take the appropriate amount of risk, you might need to save 3 to 5 times as much as the next person. Of course, it’s not realistic to expect people to completely detach from their emotions. But there is a simple and effective way to remove as much emotion from the process of investing as possible.
The solution is an age-based or risk-based investment option that does the diversification automatically. The manager of that fund will do the reallocating and the rebalancing of the fund based on your long-term goals instead of your short-term emotions.
If you have any other questions or would like more information, feel free to give us a call or send us an email. We look forward to hearing from you soon.