4 Psychological Blind Spots That Affect Your Portfolio
Learn how to avoid having your emotions derail your financial plans.
A gentleman recently came into my office for advice. He plans to retire in two years and is confused about how to position his investments for retirement. I looked at his portfolio and discovered 100% of his money was invested in one stock—his company's stock.
He admitted, "I know I have to do something, but it's hard for me to make a decision."
This gentleman has a classic case of the blind spots known as "decision overload" and "loss aversion." Common behaviors. Do you share them?
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Here are four investment blind spots that may be all too familiar to you.
1. Decision Overload
If you're preparing for retirement, or recently retired, you face a ton of decisions. Who's the right financial professional for me? What financial products can help put me on the path to financial independence? How do I protect my savings?
Being flooded with so many questions can be overwhelming. There's pressure not to mess up. It's a recipe for procrastination—analysis paralysis. As a result, many people do nothing. But that choice can be harmful for your retirement strategy.
The good news is, if you recognize this inhibiting emotion in yourself, you can proactively take steps to move forward with better financial decisions.
2. Loss Aversion
You work hard for your money and make sacrifices to accumulate a nest egg. Nobody likes to lose money. It's human nature to have an emotional attachment to the cash you've saved over a lifetime.
But the stronger our emotional attachment is to money, the more likely we are to make poor financial decisions.
Loss aversion is all about emotion and it affects our behavior. People feel cash losses much more strongly, more emotionally, than they feel gains. The motivation to avoid losses is twice as strong as the desire to make gains, according to Nobel Prize-winning psychologist Daniel Kahneman. His work has helped create more understanding about the psychology behind our money choices.
Loss aversion can pressure people to:
1. hold on to a sinking investment too long because they hope it turns around; and
2. sell gaining investments too fast because they don't want to lose the gain.
At its most extreme, loss aversion leads to the dreaded "sunk cost fallacy." That means you hold on to an asset until it's worthless. Think of Enron and WorldCom.
What's the remedy? Remove the emotional attachment to your money. I know, easier said than done. Many folks think, "Who could watch my money as closely as I do?"
But if you recognize the loss aversion emotion in your mindset, consider talking to a financial adviser about managing your investments. Advisers don't fall in love with an investment—there's no emotional attachment—and that professional detachment helps allow them to manage money objectively.
3. Hindsight Bias
You've heard the saying "hindsight is 20/20." This is a common problem among consumers. Many believe you can predict how certain investments and other financial products will perform in the future based on their past.
For example, a year ago Apple stock was selling for about $130 a share following a solid two-year run-up. In July 2015, stock analysts described Apple as a strong stock heading toward $150 a share.
That seemed like a reasonable prediction, especially if "hindsight bias" is part of your thinking. Today the stock is selling for less than $100 a share.
No one can predict the markets, and hindsight is not always 20/20 when it comes to your investment portfolio. It's important to remember that past performance is not indicative of future results.
4. The Herd Mentality
I know a bunch of guys who work together and talk about their money every day. They're managing their own 401(k) dollars and comparing notes: "You need to get into this stock and dump that one." "This one has done great for me."
Suddenly, all of their buddies hop on to an investment regardless of their age and even when it's not in their best interest.
The herd mentality spurs people to buy a stock when the price is going up, and becoming overvalued, for no better reason than "other people are doing it." It's the "hot stock."
This psychological blind spot makes investors buy high and then the market corrects itself. Don't get swept up in the emotion of the herd.
Become a Rational Investor
Money is emotion-based. It's natural for these emotions to creep into our money management, but they can produce irrational decisions.
That's why I practice what I preach. I hire wealth managers to make the buys and sells of my own investment portfolio. I help with asset allocation, but then I hand off my money to another investment team.
It's worth it to me, because when I take my emotions out of financial decisions, I have a better chance at getting a return that more than offsets the small management fee. I trust them and don't have to worry about my own emotions getting in the way of sound decisions.
The gentleman at the start of this article with all of his money in one stock has taken the first step to removing the emotions that cause financial mistakes. He knows he has some blind spots to deal with and is now seeking the help of a financial adviser.
It's our job to educate consumers about these psychological blind spots affecting financial decisions. Armed with knowledge, you can be a smarter, more rational investor.
Curt D. Knotick is a financial adviser, insurance professional and chief executive officer at Accurate Solutions Group LLC. He has more than 25 years of experience in the financial industry.
Investment advisory services offered through Global Financial Private Capital, an SEC Registered Investment Advisor.
Global Financial Private Capital (GFPC) and GF Investment Services (GFIS) have no affiliation with the news agencies represented here and the views expressed do not necessarily reflect the views of GFPC or GFIS. GFPC and GFIS make no representations or warranties about the accuracy, reliability, completeness or timeliness of the content and do not recommend or endorse any specific information contained therein.
Dave Heller contributed to this article.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Curt D. Knotick is a financial adviser, insurance professional and managing partner at Accurate Solutions Group. He hosts the radio program "Your Retirement Blueprint" with Curt Knotick.
-
Stock Market Today: Stocks Drop as Post-Election Party Ends
It was a red finish on Wall Street Friday with tech stocks selling off ahead of Nvidia's upcoming earnings event.
By Karee Venema Published
-
5 Steps to Turn Your Nest Egg into a Retirement Paycheck
Sponsored Sponsored Content by Sensible Money
By Sponsored Content Published
-
Will You Pay Taxes on Your Social Security Benefits?
You might, depending on your income, but smart financial planning now can help lower or even eliminate your taxes in the future.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
A Simple Trick for Better Investing: Stop Timing the Market
Investors who stay the course are rewarded for their patience and discipline, enjoying the benefits of compounding returns over time.
By Jonathan Dane, CFA, CFP®️ Published
-
Does a Farm Need a Different Homeowners Insurance Policy?
Homeowners insurance is all about providing the right tool for the right exposure, and life on the farm comes with different risks than life in the city.
By Karl Susman, CPCU, LUTCF, CIC, CSFP, CFS, CPIA, AAI-M, PLCS Published
-
How One Caregiver Is Navigating a Loved One's Dementia
She's spent many hours doing research and speaking with other caregivers to find her way to resources designed to help caregivers.
By Marguerita M. Cheng, CFP® & RICP® Published
-
How Trusts Can Be Used to Protect LLCs From Creditors
Combining limited liability companies with domestic asset protection trusts can achieve maximum asset protection.
By Rustin Diehl, JD, LLM Published
-
Financial Planning Tips for Business Owners Raising Kids
BORKs face specific challenges that other business owners don't, so they need a different approach to their financial plans to ensure their family is protected.
By Eric Kleinstein Published
-
How to Plan for Retirement When Only One Spouse Works
When you're married but only one spouse works, leaving retirement planning to the working partner puts financial security at risk. A joint effort is vital.
By MaryJane LeCroy, CFP® Published
-
Can a Judge Tell a Father to Avoid Risky Triathlons for His Sons?
Mom wants Dad to quit participating in triathlons, which are known to have a higher risk of sudden cardiac death, but would a family law judge force him to stop?
By H. Dennis Beaver, Esq. Published