There are simple rules to follow to prime your financial engine for more effective growth. Following these can be difficult for some, but these general rules all offer benefits. It is not enough to only prime your finances for growth though – you must also prepare and adapt your mindset and view of the world to weather the uncertainty of the market.
These are some common mental pitfalls that can torpedo your investment strategy and impede your financial wellness:
Nine Negative Investing Behaviors
- Loss Aversion: We feel loss more deeply than the happiness that comes from gains. Avoiding loss can cause you to hold on too long to a failing investment, have unrealistic expectations of low-risk investment returns, and make poor stock selections based on these expectations. It hurts, but you have to know this: some volatility and loss is to be expected in any financial model.
- Narrow Framing: When you make decisions without considering all possible implications. Narrow framing leads to market bubbles and bad investments based on hype and chasing growth that has already occurred. This can have impacts far beyond individual investors, as in the dot-com and housing bubbles of the 2000s.
- Mental Accounting: Not tracking your finances on paper can lead to varying levels of due diligence and planning. Arbitrary categorization can work against your goals, like impulse-spending your tax refund or bonus.
- Diversification: Diversification should be used as a whole across your portfolios, and be evaluated based on overall risk, rather than industry sector. Many investors chase risky profits across many industries and consider themselves “diversified.”
- Herding: It’s easy to follow the crowd and this can play off our tendency toward confirmation bias. There’s comfort here, but remember how many people lost their shirts in following the crowd on recent bubble bursts.
- Regret Aversion: We experience much more mental pain when we commit an error than when we miss on an opportunity due to inaction. This causes investors to sell too early to lock in on profits, missing out on larger gains later. Some may hold their positions too long, hoping for an upswing to erase their standing losses that grow each day.
- Media Response: Don’t be too eager to buy into what talking heads are selling you – confirmation bias can be deceiving. Failing to examine potential negative impacts or researching alternative information sources can lead to narrow thinking and narrow investing that can net big losses.
- Overconfidence: Nobody can constantly beat the market. Even investing “gurus” take consistent losses in their financial models. If you don’t plan to roll with the punches and absorb volatility, your financial model will quickly be broken and you could wind up broke.
- Anchoring: Our previous experiences inform our outlook, worldview, and plans for tackling the future. Even if they don’t apply. These informational anchors can hold you down if you fail to recognize them for what they are and move beyond this frame of reference.
These negative behaviors can cause you to abandon key points of your financial model and sound investment strategy. Remember, it’s all about time in the market, not timing the market. If you want to grow your wealth you need to face some intellectual discomfort to recognize and overcome these negative behavioral impulses in yourself.
Your Investment Policy Statement
A powerful way to overcome these negative tendencies in yourself is to draft a personal Investment Policy Statement. Much like a personal manifesto or a company’s mission statement, this is meant to help you unify behind a vision guiding your investment strategy toward your financial goals. Some areas to consider including are:
- Purpose: What is your purpose and goal for your IPS?
- Values: What values guide your life and decisions? How do you want your investment decisions to support these?
- Objectives: What do you want to achieve through your investments? What timeline, risk tolerance, and performance objectives figure into those goals?
- Duties: What role does everyone on your investment team play? What is your involvement? What expectations do you have for yourself and the rest of your team?
- Portfolio selection: What investments (based on your previous statements) will comprise your portfolio? Laying out a complete picture here can be a powerful evaluative tool.
- Performance: How do you select your investments and what standards must they meet in order to remain as a holding or purchase goal? Base these decisions on your statements and objective facts.
- Costs: Any costs associated with managing your portfolio should be 100% transparent.
- Review: How often will your portfolio and IPS be reviewed? We recommend at least annually. Make sure that as your life changes you update your strategies to fit your future needs.
With the right mindset and a clear investment policy guiding your financial model, you can hack your future and grow your wealth more effectively. These are real steps towards true financial freedom, of being able to rely on your own wealth for your future. Want to figure out the path forward together? Contact us to schedule a consultation.