3 Market Mistakes You Can Outthink
01/16/2012 10:30 am EST
It's not always easy and no one always succeeds, but making these three issues an integral part of your investment decisions will help you in the long term, writes MoneyShow.com personal finance expert Terry Savage.
If you want to be a successful trader (or simply manage your personal finances wisely) you need to recognize the importance of “mind over money.” All the knowledge in the world won’t help you become successful if you lack knowledge and self-discipline.
You’ve all heard the ordinary instructions about managing your money and investing successfully. Think rationally. Don’t behave emotionally. Be disciplined.
Well, it’s easier said than done. Maybe that’s why most people kick themselves for selling at the bottom, and rue the day they bought at the top of the market. Or why the post-holiday hangover of credit card bills makes you wonder what you were thinking that last week of shopping.
You’ve heard the rules before—and later in this column, I’ll give you three basic money mistakes to overcome. But first, there’s a new book out with a fascinating approach to dealing with the emotions of money management.
Denise Shull, author of Market Mind Games, is an internationally recognized pioneer in the new psychology of risk and uncertainty. She’s the founder of ReThink Group, Inc., a New York-based consulting firm that helps increase performance by using the science called neuroeconomics, an interesting approach to behavioral economics.
Basically, what Shull advises is not that you try to beat down all your emotions so they don’t impact your investment performance. She says that’s not only impossible, but counter-productive. Every decision includes an emotion.
So instead, Shull advises that you recognize the impact of those emotions—the meaning they are imparting to your thinking. After all, it isn’t the emotion that needs controlled, it is the actions you take that need to be directed.
Shull says you need to feel, acknowledge, and deal with your emotions in order to gain the advantage—and trade or invest successfully. The feelings themselves become “data” to be incorporated into your decision making process.
Market Mind Games reads more like a mystery romance novel than a psychological dissertation. It is must-reading for anyone who intends to do more than just invest a regular amount monthly into a diversified 40l(k) portfolio.
That’s not to say that a regular dollar investment is a bad idea. In fact, for most people, who have neither the time nor the self-discipline to read this book, a long-term monthly investment plan is truly a better solution.
Then again, you might want to read this book just for the knowledge of how your emotions rule your brain—and to learn how to recognize the urge to dump your plan—and your stocks—in a moment of panic.
Now, if you’re looking to do things differently this year, here are the three big money mistakes you probably made last year—and how to make sure you don’t’ make them again this year!
Money Mistake No. 1: Closing Our Eyes
No one wants to hear bad news. And these days, you’re likely to find bad news when you open your bank statement, credit card bill, or your 40l(k) or IRA statements. There are some people who simply toss their stock market investment envelopes in the drawer and never open them!
But things will never get better if you don’t open your eyes, take a close look at the details...and then get the big picture. And this is the right time of year to do it, because you’re getting your year-end statements.
Make lists of what you own (your investments), of what you owe (your bills), and of your goals. Open your eyes to face reality. Like it or not, this is you—and you need to know where you stand in order to change things. And if you can’t figure out how to do that on your own? Seek help.
Which brings us to the second mistake.
Money Mistake No. 2: Being Stubborn
If you’ve “always done it this way” and it’s still working, that’s fine. But if you don’t like your current financial situation, you have to change!
Change is difficult for everyone—some more than others. We’re talking about being open to change everything, from how you pay your bills, to what credit cards you carry in your wallet, and even to changing the mutual funds in your IRA or 40l(k).
Ask yourself why you’re doing things this way—and then ask around or do some online research to see if there is a better way of doing things. Values and principles don’t change—but time and technology change techniques and opportunities.
You have to be open to change as well. Especially if you want different results.
Money Mistake No. 3: Making Emotional Decisions
There are two emotions that confront you whenever you make financial decisions: fear and greed. (Although greed may be better defined as the “fear of missing out.”)
Think about it. You never deal with those emotions when you’re deciding what movie to see, or what dress to buy. But money decisions bring out these two motivators, and they often override common sense.
We all know how dangerous greed is—it makes you think home prices or stock prices will rise forever. But fear can be equally dangerous, because it paralyzes you, and can keep you from taking appropriate risk.
The trick is to know when fear is a good risk management signal and when it is something else. Making that decision requires you to stop before acting, and to think rationally about the issue.
You can’t stop these emotions from appearing, but you can recognize them and resolve never to act out of panic, without thinking through the consequences of each financial decision.
Unless you’re perfectly happy with last year’s results, do at least one thing differently this year. At least you won’t be bored! And that’s The Savage Truth.