The Psychology of Investing

Posted by Freedom Advisors on Aug 21, 2020 6:15:00 AM

Many people believe that the smartest investors are the most successful investors. They think that a brilliant mind can suss out the nooks and crannies of the stock market where profits hide and can calculate how to best leverage that knowledge. Many people also believe that it’s important to respond quickly to shifts in the market to take advantage of opportunity, and even more so, to defend one’s holdings against potential loss.

There is a lot of fascinating theory available on the psychology of human behavior around loss aversion.* In general, people are more motivated to take action when they perceive that they are at risk of loss. Additionally, they tend to assume that their smarts will get them through the ups and downs of the market. However, it’s not genius-level intelligence that will get your clients through market volatility and change—it’s persistence and patience.

Success in investing doesn't correlate with I.Q. . .

Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.


— Warren Buffett

An investor’s impatience and fears are often the root of their biggest downfalls. Their impulses to act fast can lead them to make poor decisions to sell at the wrong time, and the consequences may sometimes be heavy losses. Other times, intense excitement about an up market can fuel desire to maximize profit, and this emotion may similarly cause an investor to suffer an unplanned-for tax burden that often follows gains, and they feel blindsided.

How to Maintain Equilibrium

But how to help clients stay calm in these storms? It’s easy: make a plan. Then stick to your plan. When clients make impulsive decisions that are not part of your plan, the risk increases. The likelihood of loss rises. Although it can be tempting to take swift action when the markets are shifting, often the best course of action is not to take any.

In the midst of what feels like a scary fall or even a thrilling uptick, the temptation many investors have is to react suddenly. They try to buy or sell in order to protect themselves or to maximize profit, but because these are short term goals, these maneuvers may backfire for your long-term security.

Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.


— Paul Samuelson

Each investor should approach their holdings with a specific goal in mind. For some, it may be building wealth for the next generation. For others it may be maintaining income through retirement. Others may dream of saving for a second home or significant charitable giving. No matter the investor’s goal, working with you to determine appropriate investment strategies will help clients reach those objectives.

Get Some Perspective

Whether clients are feeling anxious or exhilarated, take the time to discuss their feelings—before they act. Any seasoned advisor that has worked through periods of market volatility has seen how investor behavior can affect investments. Together you can discuss concerns and help rein in any impulses to take action that clients may regret later.

The investment plan you and your clients built together takes into account fluctuations of the market. To stay stable and secure, most advisors recommend that clients stick to their plan. Although some investors may have to white-knuckle their chairs a bit, their long-term goals are more likely to be borne out through patience and perseverance.

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Advisory services are offered through Freedom Investment Management, Inc. ("Freedom") a registered investment adviser. The information contained herein is for informational and comparison purposes only and should not be relied on or construed as financial advice. The representations and opinions herein are the opinions and view of Freedom. When applicable, sources used in forming Freedom’s opinion are cited, however, other sources may be available which contradict Freedom’s opinion, process, and methodology. All investment strategies carry varying degrees of risk(s), which may include a total loss of invested assets as such risk(s) should be carefully considered and evaluated before investing. Potential investors are advised to consult with their financial, tax and/or legal advisors prior to investing. Freedom does not provide tax or legal advice.

Topics: Investing

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