Emotions vs. Rationality

Have you ever opened a quarterly investment statement and felt a wave of optimism after seeing a big gain?
The emotions are undeniable—satisfaction, happiness, and hope for the future. But what happens when you face a statement after a downturn, like the infamous first quarter of 2020? Panic, pessimism, and the urge to act impulsively can cloud your judgment, potentially leading to costly mistakes.

Even if your investments are intended for a future 10-20 years away, the emotional highs and lows can feel immediate. Rationally, we know investing is a marathon, not a sprint, but our emotions often have other plans. To help you navigate these emotional traps, let's explore five common pitfalls—and how to avoid them.

Pitfall #1: Mental Accounting

We often divide our money into different “mental accounts” of perceived value, even though a dollar is a dollar no matter its source.

For instance:

• Hard-earned money may feel more precious than a $1,000 windfall from a casino.
• A person might gamble away casino winnings aggressively but be overly cautious with their paycheck investments.

This mindset can lead to overly conservative or overly risky decisions depending on the "mental account" the money comes from. Recognizing this behavior can help you make more balanced financial choices.

Pitfall #2: Confirmation Bias

Do you only seek information that aligns with what you already believe?
This is confirmation bias at work. In investing, it can be dangerous—like focusing only on positive news about a stock you want to buy while ignoring red flags.

Instead, strive for objectivity. Evaluate all available information to make well-rounded decisions. Remember: Your money deserves more than just a second opinion—it deserves the right one.

Pitfall #3: Overconfidence

"I can beat the market."
This common belief can lead to overestimating your ability to predict stock trends or time the market. Overconfidence often results in:

• Panic selling during downturns, locking in losses.
• Chasing gains by buying high and suffering when prices correct.

Successful investors know the value of patience. Markets rise and fall, but staying the course often yields better results than reacting emotionally.

Pitfall #4: Following the herd

Herding is another behavior where we do not want to go out on a limb because if we are wrong there is a loss of reputation, but if we stay with the crowd and they are wrong, no damage done. An example might be that, because the talking heads on investment TV shows are talking up a company, and my friends are buying stock in that company, than it would be foolish for me to not buy that stock. We want a “piece of the action.”

An example might be the feeling that I need to buy TESLA stock or bitcoin because so many people are talking about them, but not fully understanding why I should buy them.

A more dangerous example of herding (and chasing gains) might be those that jumped in late to buy Game Stop stock recently when it was going up rapidly because their DIY investor friends were doing it, only to be left holding the bag when the short squeeze bubble burst!

Pitfall #5: Taking mental shortcuts (heuristics)

Heuristics is when we take short cuts in our decision-making process and do not do our homework. Here we discuss 3 components of heuristics: representativeness, availability, and anchoring.

Representativeness is when we make decisions based on similar things that have happened in the past. There is the saying: “Those that don’t learn from history are doomed to repeat it.” Understanding why something happened in the past, say the profits of a particular company in a particular situation, may lead to a more profitable investment decision than just trying to copy or mimic yesterday’s news.

Availability is where we decide based on only recent news and events and do not consider long-term history. An example of this is buying only growth stocks because they have outperformed value stocks in the past three years, whereas in the past twenty years value stocks have generally performed better over the long haul.

Anchoring is where we make investment decisions based on a specific price. An example might be to sell one’s house when it attains a certain value, only to have that value more than double ten years later.

How a financial advisor supports your rationality

These and other emotional decisions can lead us off the path of sound investing. Partnering with an informed, objective, and fiduciary financial advisor can help a person stay on the right path and make rational decisions instead of emotional ones as we save for retirement. For more information on how we can help you please visit us at www.f5fp.com, or schedule a free consultation here.

Would You Like More Support?

---

• Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?

---

• If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?

---

If so, feel free to send us an email or give us a call. We’d love to have the opportunity to help you find a bit more peace of mind when it comes to investing.

Photo credits: rawpixel.com