Our emotions play a big role in our decision making, whether we realize it or not. We like to think that the choices we make are the result of a thoughtful, rational evaluation of the available options. In reality, we are emotional creatures who sometimes make decisions based on preferences, habits, and feelings. When it comes to investing, letting emotions drive our investment decisions can be detrimental to our long term plans. Perhaps you’ve been in situations like the hypothetical examples below.
Say for instance, Bill purchased some XYZ stock in his early 30s and it went nowhere but up. He used the gains from this stock to buy cars, a house, and supplement his family income to pay for his three kids in college. Bill may now feel like he is a prudent, wise investor. However, he may have an unhealthy emotional attachment to this particular stock. Bill could be a wise investment manager, or his choice of XYZ stock could have been a stroke of dumb luck. Fast forward 30 years and XYZ stock has been consistently down for the last 10 of those years. He refuses to sell this stock and actually talks about it like it’s an old friend instead of an investment tool. From a rational standpoint, it may be time for Bill to cut his losses and sell some or all of the stock. Bill decides to hold on to XYZ and “ride it out.” He is making decisions purely on emotion, not facts or concrete information.
Another example is Francine who worked at LMNOP Company for 37 loyal years. She has since retired, but has extremely fond memories of her time with LMNOP and considers her former colleagues family. LMNOP matched all employee 401(k) contributions with LMNOP stock and offered an Employee Stock Purchase Plan to allow employees to buy the company stock at a 10% discount. Francine participated in both of these programs and now has an investment portfolio that is 47% LMNOP stock. She has had several chances to diversify her holdings while working at LMNOP, but felt good about owning a stock within her beloved company. Now that she is retired, there are absolutely no restrictions on the amount of LMNOP stock that she can sell to diversify her portfolio. She held onto the stock, even when she heard that LMNOP is offering a voluntary severance package and has laid off half of their workforce in the past few years. Francine will likely hold onto this stock, even if it continues to decrease in value. After all, she can’t sell out of the company that was like her family all this time!
Then there is Sally. Sally is a widow who was never involved in the family finances until her husband passed away. Sally now has to figure out where all of her assets are and what she owns. She knows that her late husband, Fred, was a big fan of investing in silver bars and kept a large stash of them in a fire-proof safe in the basement, and an even larger stash in a private company vault. He also believed that accumulating cash value in a life insurance policy was a good way to invest and save money, so he had several policies in place on the couple. After a few years, cash flow became pretty tight for Sally and she was having a hard time paying the bills. The growing cost of the life insurance premiums and the storage fees for the silver bars was putting a strain on her finances. Sally could sell the silver and save herself the cost of storage. She could also take the cash value of the life insurance policies and discontinue paying the hefty premiums. Sally and Fred had never discussed how assets should be managed after he was gone, but she assumed that he would want her to continue investing the way he had. However, it seems likely that Fred would want Sally to do whatever she needed to do to live a happy, healthy, and financially stable life.
You may have found yourself or someone you love in circumstances like Bill, Francine, or Sally. The common thread is that people often make decisions based on emotion and not rational facts. It is unrealistic to expect everyone to be rational at all times, but such decisions can endanger their livelihood.
I can’t change how people behave; I believe that the problem and the solution are driven by emotion. Silver, too much life insurance, the XYZ and LMNOP stock were all good investments at one time, but may not be the best going forward. What may change their minds is a stronger emotion outweighing their existing preferences. Sally may one day wake up and realize that she has no other assets and can no longer afford her home. Her fear of losing the house and not living the lifestyle she has become accustomed to may drive her to sell the silver and discontinue the life insurance. Francine may become overwhelmed with thankfulness that LMNOP provided such a great experience and income for 37 years, but now she can diversify her portfolio and instead purchase her former company’s products as a way to show her support. Bill may realize that he does not want the children he put through college to be supporting him for the rest of his life, so he may decide that it’s time to part ways from XYZ stock.
These stories could have a happy ending or a tragic one; it’s a matter of mindset. It’s important to be grateful for past fortune (or luck), but we must realize that the world is constantly changing and we must adapt. Certain decisions may have been successful at one point in time, but they may not be the right decision now or in the future.