Finance, in general, is based on rational and logical theories, and for the most part, tends to be somewhat predictable. Early financial theories assumed that people behave rationally and predictably and that outside factors and emotions do not influence people when making financial decisions. However, behavioral finance has proven that people behave irrationally and differently in the real world.
The human brain has difficulty assessing risk (fear) and possibility (greed), which causes our emotions to affect our decision-making process. Investors tend to make irrational decisions when it comes to their investments. Investors react stronger (it’s painful) to financial loss than gain. This reaction is what has the most impact on our portfolio aside from investment performance. Fear and greed are such powerful emotions that there is now a Fear & Greed Index that tracks what drives the stock market today!
In thinking about yourself, do you react to televised market commentary or to ‘Herd Instinct’ causing you to invest in something because everyone else is? When the market declines, are you fearful of loss and sell or invest or hold onto an investment in a down market? Fear and greed can be beneficial to your portfolio or have the opposite effect.
As Warren Buffet said, "Be fearful when others are greedy and greedy when others are fearful."
Discussing your fears and financial dreams can give both the investor and financial professional a better understanding of what may cause bad decisions leading to errors that you may not recover from.
Hearing the term ‘greed’ isn’t wrong unless it leads to thoughts of confusion, questioning decisions, or behavior changes similar to ‘gambling’ on an investment. As an investor, you can have a ‘financial crisis' by not fully thinking about what you want and how you will react to changes in the markets. You need to know yourself before you can determine your goals and start to invest.
How much market fluctuation can you tolerate? Are you comfortable with separating money into different investment options to help fund each goal you have? Are you satisfied with investment advice and the monitoring of your portfolio? The best way to harness fear and greed to your benefit is by understanding your investor profile:
Objective Traits- Personal or social traits such as gender, age, income, family, even tax situation
Subjective Attitudes- Part of the emotions and beliefs of the investor.
Balancing Risk vs. Reward- Tolerating more risk to have a higher reward or less risk and contentment with a reasonable return.
Area of Focus- Types of investments (ex. Stocks, bonds) and sectors of investments (ex. Technology).
Investment Strategies- Helps to shape the investor profile by the types of investments the investor uses (ex. ethical, growth, indexes)
Valuation Methods- Helps develop the investor profile through the valuation method (ex. Fundamental analysis, technical analysis, quantitative analysis).
Work with your financial professional to develop a strategy to ensure your investor profile fits your portfolio and addresses your fear and greed toward investing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Past performance is no guarantee of future results.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
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