Feelings Are Normal, But Not Reliable Investment Guides

by | Sep 12, 2016 | *Financial Awakenings, Fee Only Financial Planning, Healthy Money Relationships, Investment, Money Psychology, Weekly Column

panicThe first week of January 2016 I talked with a retired man in need of some retirement planning. He had a portfolio of about $1,000,000 invested in money market and certificates of deposit. His Social Security income was about $25,000 and his lifestyle spending was around $60,000, meaning he needed to withdraw about 3.5% annually from his portfolio to make up the $35,000 difference.

A 3.5% withdrawal rate is very realistic to provide a high probability of never running out of money. For a diversified retirement portfolio (defined as 40 percent bonds and 60 percent global stocks, real estate, commodities, and investment strategies), my research would suggest a long term return of 5% is reasonable to expect.

I wish I could tell you this man invested his $1,000,000 in January, but he elected to keep his money in cash. Why? “I have a bad feeling about the market. I think it’s going to crash.” Guess what? He was right. Global stock markets did crash, spectacularly.

By the second week of February a portfolio of global stocks was down almost 12%. Had he invested in a diversified portfolio in January, he would have been down 3%. With only a third of his portfolio in global stocks, the rest would have been in other investments that collectively did much better than equities. Still, by keeping his money in cash he was $30,000 richer than if he had followed my advice.

This story would have had a very happy ending had he invested in mid February when the global markets started back up. Unfortunately, he still had a “bad feeling,” that the upturn wouldn’t last and the market would drift even lower. So he waited.

Fast forward to August 2016. Global stock markets rose spectacularly from mid February and were now up around 8% for the year. Had he invested in January, the 3% loss he would have seen in February would have become a 7% gain. His retirement portfolio would be up $70,000. Instead, he had earned .2% on his cash, a $2,000 gain. His decision not to invest has cost him $68,000 so far.

He still has a “bad feeling” about investing because the US stock market is now at an all-time high. He reasons it will eventually crash, and he will get in then. While he is sad to have missed out on earning $68,000, he is convinced his “bad feeling” will prove him right in the long run.

Maybe it will. The evidence and research, however, is not on his side.

When it comes to investing, it’s crucial to be aware of our feelings. Yet acting on the stories we make up around those feelings can be detrimental and costly. Here are some of the stories this investor made up:
If the stock market goes down, everything in my portfolio will go down equally. Not true.
Investing when the market is high is a guarantee of losing money. Not true. Value is based on earnings per share of stock as well as the price of a share. Based on the price to earnings history, there could be plenty of room for the market to continue to rise.
When markets go down, I’ll be able to invest at or near the bottom. This is rarely the case. Plus he already had been unable to do this in February; why should he expect to be able to do so in the future?

Feelings of fear, panic, desperation, greed, and remorse around investing are normal. Successful investing, however, requires letting those feelings pass and taking actions based on sound logic, probabilities, and historical research.

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