Don’t Let Instinct Ruin Your Financial Plan

The human instinct to focus only on immediate threats to our well-being is hard-wired. It evolved because it kept early humans physically safe. But while the instinct to run from danger was invaluable to a Neanderthal roaming the savanna as a hunter/gatherer, it can be devastating to a long-term financial plan.

Just think about the violent swings in global stock markets in the recent past. Most investors couldn’t see beyond the 1,000-point plunge in the Dow and what they thought it would do to their financial future. Some investors acted on instinct and ran — sold their shares and got out.

Why does the crowd act irrationally, making this common investor mistake of buying high and selling low? The answer lies in monomania, a psychosis characterized by a pathological obsession with a single idea or group of ideas. People afflicted simply cannot see the big picture. Their behavior is driven by their obsession and is irrational in the overall context.

In recent weeks, investors ignored the fact that the market has risen more than 100% in the past several years and focused instead on a few days of scary selling. Transfixed by the negative short-term events, they ignored the long-term upward trend of the market.

In her excellent book “Rapt,” author Winifred Gallagher talks about how “energy flows where attention goes.” In this case, many investors’ attention was on this short-term swing, so their energy went to selling their investments in a state of panic. People tend to choose behavior that gives them quick rewards, Gallagher says. Here, investors sold their stock to relieve the pain of losing money — even though it was the selling that turned paper losses into real losses.

So how do we avoid this negative pattern of decision-making and change our focus from negativity to opportunity, especially when it comes to investing?

First, we need to plan how we will act in advance. If you know you react badly to periodic stock selloffs, it might be a good idea to not watch TV on those days. Is it necessary to get minute-by-minute updates of the carnage? Deciding on a plan of action before the event rather than during it will make a huge difference in the eventual outcome.

“You need to direct attention away from paralyzing gloom and self-pity toward a big picture that puts loss into perspective,” Gallagher writes. This could simply mean reminding yourself that in order for anyone to make money in the stock market, stocks have to go down sometimes. Or understanding that a 12% drop isn’t even all that uncommon over the long history of the stock market. Such a perspective is desperately needed during these times.

Or, consider this comforting thought from MarketWatch columnist Brett Arends last week: If you were one of the unluckiest people on the planet and invested all of your money the day before Lehman Brothers collapsed in 2008, you still would be up 80% today.

This kind of shift in perspective can help you make better decisions on the days markets are wobbly. If you direct all of your energy to the negative aspects of an event, it will be impossible for you to see any opportunities that may result from it.

For example, many stocks have dividend payouts higher than the yield on 10-year Treasury notes. When this happens, it’s usually a sign that the market is approaching a bottom. If you thought it was a good idea to buy stocks a few months ago, the fact that prices are 12% cheaper should make you happy.

This, of course, runs contrary to what many pundits will say, as they caution you to follow your instincts, to run away from danger, to convert to cash during dangerous times. But when markets go down, they actually become less risky. Purchasing at lower levels increases your probability of higher future returns.

You could also look overseas for potential long-term benefits. Many emerging market stocks are selling at cheaper levels than they were five years ago. Many foreign developed markets are selling at a substantial discount to the U.S. and have become even cheaper.

Whatever the investment strategy, the bottom line is that looking for opportunity during mayhem is almost always a better tactic than focusing on preconceived notions of negativity and gloom. While there are no guarantees in life or investing, shifting your attitude should give you a better chance of having more rewarding experiences both personally and financially.

Focus your attention on the good stuff — what do you have to lose?

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