Emotional Investing Can Traumatize Your Savings Strategy
When it comes to investing, we like to think of ourselves as rational beings – unbiased when it comes to making decisions affecting our long-term financial futures. In many instances, that’s simply not the case.
Humans are emotional creatures. Pursuing financial stability in the here and now - and in those later years - is one thing. The associated pursuit of security (minimizing risk) is another. The two often clash out of emotion.
Folks often frame financial decisions incautiously in the pursuit of financial stability as opposed to optimizing security, and vice versa.
Here's a few examples to illustrate my case...
Safe Saving is Limiting
Over the recent couple of decades, many of us viewed cash as a riskless asset. Because interest rates were so low, we found a safe place to store surplus cash and forgot about it until needed. But for most of those aforementioned decades, our cash (after taxes) was yielding less than inflation, a sure way to lock in “deteriorating spending power."
In short, this pursuit of security caused us to sacrifice a portion of our financial stability. Our cash was safe but losing value.
FDIC Can Cost You
We live in a world of inverted yield curves - one where short-term debt instruments (bonds, notes, etc.) have a greater yield than longer term instruments. This is a phenomenon usually caused by expectations of an impending recession. Some among us suggest that it’s not worth the aggravation to move cash from a lower-yielding, FDIC-insured CD or bank savings account to a higher-yielding money market mutual fund. They say that losing the security of FDIC insurance to earn just a few more dollars is not worth it.
In not doing so, they sacrifice extra interest income on the altar of achieving minimally enhanced security.
Don't Lose $$ Paying Lower Taxes
And how many times have you heard friends or acquaintances say, “I want to pay the least amount of taxes possible”? Wouldn’t the better objective be to make more money after taxes? Folks often jump through hoops to reduce their tax load but in the process forego revenue greater than those taxes saved.
Own the Market
An emotion related to investing we’ve likely experienced is that losing money causes more consternation than making the same amount. And let’s be honest, investing is really about outpacing those you perceive to be competitors in the marketplace. So why not “own the market” at a very low transaction cost – today, close to zero - by making quality investments (indexing) and holding on through thick and thin versus the competition that constantly trades?
Study after study shows that over time indexing will increase one’s likelihood of winning that competition from both a financial AND risk reduction perspective.
In a past blog, I discussed the enhanced value of inflation-adjusted Social Security income versus streams of income from bonds, company pensions, annuities and equities. When people suggest that non inflation-adjusted proceeds provide them with paychecks throughout retirement, that’s true enough. But a couple of decades suffering the ravages of Izzy the Inflation Monster during those golden years could reduce the purchasing power of those other income streams dramatically.
Yes, investors should develop several income sources, but the decision to optimize Social Security payments by waiting until age 70 to start receiving them can benefit the recipient both financially and from a security angle as well. There is an element of longevity risk associated with such delays.
Investing is, by nature, risky and needs to be approached with caution following certain basic principles. My simple portfolio is built around low-cost, high-quality, highly-diversified index funds, using patience in its administration – and controlling my emotional tendencies by staying the course during volatile times.