SMART MONEY: Emotions Are the Enemy of Good Decisions
By Brad Brain
Making money is easy. You just have to buy low and to sell high.
This fundamental principle is easily understood. If you ask the average person if they know what “buy low, sell high” means, they’ll nod and say of course they do. It’s basic. It’s logical. It makes sense.
But then something curious happens. People don’t actually do it.
The evidence of this is indisputable. If you track the flows of money in and out of investments, on average people will sell an investment if it goes down and they will buy an investment after it goes up.
This, of course, is the exact opposite of what we just talked about. People understand the theory of “buy low, sell high”, but in practice many people will still “sell low, buy high.”
It doesn’t matter that this is illogical. It’s been shown over and over and over to be true.
Now, some people might be reading this and thinking “What a bunch of idiots, I would never do something so dumb.”
Perhaps. But the people that do this are not necessarily dumb. They just don’t recognize
their own behaviour for what it is.
You see, here is the thing. Typically, there is a reason for an investment to be trading where it is. And most people make money decisions, not based on reasoned analysis of the facts, but on unfiltered emotions like fear and greed.
If an investment is trading at a cheap price, for some reason or another, the future looks uncertain. The question is, can you set your fear aside and make a rational decision? When your quarterly statement is showing your account value plunging lower and lower and lower, can you set aside your fear? Can you resist the thinking “I need to sell now before I lose even more money?”
If an investment is trading at an expensive price, for some reason or another, the future looks compelling. Now the question is, can you set your greed aside and make a rational decision? When you keep hearing how much money someone made on this investment, and you watch it move even higher still, can you set aside your greed? Can you resist the thinking “I need to get in quick before I miss out?”
We only have to look at recent history to see what this looks like in real life. In the turmoil of the Trump Tariffs, were you apprehensive? Were you worried that you were going to lose money? Did you sell any investments?
If we are going to strictly follow the rational “buy low, sell high” theory, then that was the time to put some money to work. Did you look at the recent market volatility as a buying opportunity?
This is what it looks like in real life. It’s messy. Nobody rings a bell, and says, “Here you go. This is your clear signal that it is time to buy.”
Instead, you have to make decisions based on imperfect information. You don’t know the future. You never will. You just have to do the best you can.
The good news is that you don’t have to know the future in order to make rational decisions about your money.
The first thing to do is to define your financial objectives. Believe it or not, there are a lot of people that aren’t really sure what they want to do with their money. When you know where you want to get to, you can make decisions that are consistent with your objectives. Someone who is saving for retirement that is many decades in the future is going to look at things differently than someone who is saving to buy a house in six months.
Many people would benefit from regular contributions to their long-term investments. The term for this is dollar cost averaging, and it’s a beautiful thing. Dollar cost averaging takes the guesswork out of when to invest. When you are buying every month, it really doesn’t matter if the big sale happens in April or May or June, if you are buying in April and May and June.
Use history as a guide. Every time we see a crisis some people think its unprecedented. But it isn’t. We have had wars, recessions, pandemics, inflation, trade disputes, you name it. Been there, done that. This time is not different. It never is.
We all feel emotions when it comes to our money. That’s natural. But the challenge is not letting those emotions drive our decisions. Like Warren Buffett says, to invest successfully over your lifetime you need a strong intellectual framework for making decisions, and the ability to keep emotions from corroding that framework.
Emotions are the enemy of good decisions. If you want to be a successful investor, you need more than just the knowledge of what to do. You need the discipline to stick to the plan.
Brad Brain. CFP, R.F.P., CIM, TEP is a Certified Financial Planner in Fort St John, BC. This material is prepared for general circulation and may not reflect your individual financial circumstances. Brad can be reached at www.bradbrainfinancial.com.