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Emotional Bias in Financial Planning: What to Do About It

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Emotional Bias and Crises as Permanent Risks in Wealth Management and Financial Planning: What to Do About Them

Emotional decision-making is bad decision-making. As the COVID pandemic demonstrated, emotion-driven choices can roil financial markets and destroy wealth, and they’re unnecessary.

In 2020, COVID-19-pandemic-related market volatility was the highest volatility since Black Monday in 1987, and the largest volatility spike linked to a disease outbreak in history.

Living through the COVID-19 pandemic has been stressful enough. Adding the stress of worrying about market performance is adding injury to injury. If it caused you to take action and alter your investments, it probably worsened your financial well-being in the long run.

If you’re one of many who worry about their investments in the middle of the crisis, there are some dependable ways to reduce stress and make a plan moving forward.

Even better, there are ways to approach investing and financial planning that can limit emotional decision-making in the first place.

Prioritizing Your Mental Health

Psychological professionals have long acknowledged the detrimental effects of stress on well-being. Stress impacts sleep, cognition, and overall physical health. In times of financial and social uncertainty, it’s important first to regulate your mental well-being. High-stress levels actually change human perception, increasing the likelihood of impulsive decision-making. Due to this, it’s wise to consider certain stress-managing lifestyle changes before making any big investment-related decisions. 

Reducing Stress Without Changing Your Finances

Stress makes us feel as if we’re losing control. This is why it’s vital to take control of your lifestyle, independent of finances, wherever you can. The following suggestions have been proven to have positive effects:

  • Focus on wellness. They’re timeworn suggestions, but they work great for well-being: exercise regularly, get enough sleep, eat well and practice mindfulness. Allocate time to engage in recreational activities that make you happy or explore a new hobby.
  • Don't use unhealthy coping mechanisms. These can be harder to recognize than one might expect. Don’t smoke or drink in excess to cope with stress, but also be wary of overworking yourself and unnecessary risk-taking.
  • Stay socially connected. Social support increases resilience to stress.     Experiencing the combined effects of financial stress and social distancing measures from coronavirus makes people susceptible to feelings of isolation. Lean into your support system and connect with others to avoid feeling consumed by anxious thoughts.

Take a Break 

Over-checking your portfolio is ill-advised for financial well-being in general and even more so during market downturns. For most, investing is a long-term proposition. Constantly checking your investments is not only unnecessary but often a source of aggravated stress. The same goes for overconsuming news about the stock market. These can increase the chance of making ill-considered, emotionally-driven decisions. It may be in your best interest to step away from your investments momentarily in order to gain perspective.

You Could Assess Your Investing Goals, but Should You? 

Are periods of volatility a great time to reassess your portfolio? Or should you simply remind yourself of your long-term goals and resist the impulse to reassess? Presumably, you took some time and reflection to choose specific investments. Why are you investing in the first place? Despite volatility, it’s probable that an investor’s long-term goals remain unchanged. Doing nothing and avoiding impulsive behavior is very often the prudent course in life, including investing.

Making Time Work in Your Favor 

If you have an advisor, by all means, talk to them about your concerns. If you don’t have an advisor and think it’s time to work with one, there’s no time like the present. No matter your circumstances, the fundamental piece of advice is to avoid making a hasty, costly decision. 

The best way to do this is to make time your ally. If you can afford to leave an investment alone for at least seven or eight years or preferably ten, you can ignore your feelings. 

If you’re investing, you want to buy low and sell high. Nothing new there.

One of the key ways to avoid selling low is to avoid getting stuck in a position where you’re forced to sell when you don’t want to. If you accumulate a reserve cash fund, and if you have a portion of your investments allocated to moderately conservative holdings, then you have money to access when you need it. 

Now time is your ally because your higher-returning but higher-volatility investments don’t need to be touched. You can wait out the bear market downturns – because although bear markets average losses of more than thirty percent, bull markets are much longer in duration and come with average gains of over one hundred fifty percent.1

Advisors who encourage you to ignore it all and stop watching your investments and financial media during times of major volatility are earning their keep. Consider listening to them! Refer your friends to them to help your friends avoid doing something foolish. 

If you combine this patience with investing in top-flight companies, temporary market weakness can actually promote long-term wealth accumulation. Great companies are disciplined about retaining their earnings and reinvesting them successfully. Bear markets mean lower asset prices. Whether a well-managed company is buying back its undervalued stock or making acquisitions of competitors that are selling cheap, good companies plus retained earnings plus bear markets equal long-term wealth for the shareholder.

Patience, a long time horizon, and a commitment to ignore emotional impulses - your wealth management and financial planning will benefit from all of them.

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