By our very nature, we are emotional creatures. Yes, even you guys get emotional
too! If you are not convinced, watch a close scoring football game, or better
yet, a high school lacrosse match.
Most of us view our negative emotions as a call to action. If our children are unhappy, we want to make
the happy. If someone close to us is sad and crying, we want to cheer them up.
If we are afraid of something, we suppress the fear and pretend it isn’t there.
On the other hand, I have never seen a mother try to control their child’s enthusiasm
or happiness. Laughter is wonderful medicine. We dance, clap and sing to our
favorite music. We celebrate and enjoy positive feelings. They feel good and we seek to expand our positive emotions.
Why do we see negative emotions as a call to action, suppression or avoidance? We were not born this
way. In a recent investment management meeting with a young mother and her six-month
old baby, I was reminded of just how spontaneous and in-the-moment babies can
be. As we went over her portfolio analysis and details like investment performance,
beta, alpha, and asset composition, the baby cried, laughed, and smiled. Quite
a range of emotions for a one hour meeting!
What I learned, or re-learned, from this child, is that she did not need to fix her feelings. She just felt
them. She did not make them positive or negative, good or bad. They just were. She made no life-altering decisions in her moments
of high emotion.
What does this have to do with investing? Everything! When the market goes down,
we feel fear, which is one of the feelings we have classified as negative, and it becomes an emotional call to action. We may sell our investments to
protect ourselves; fire our financial advisor because “they should have known”;
or hide our head in the sand and pretend its not happening. All of these are
emotional reactions to feelings of fear…and none of these are actions that create
resolution or restitution.
We know that investing is a long-term process. We know that the stock market
goes up and down. When we are making an investment decision, we are analytical.
We see the historical market returns, and we focus mostly on the positive ones. We look at the negative ones and say, “The market always recovered.” But what we often fail to consider
is…how am I going to process the feelings and emotions that come when the market
drops?
The challenge comes when we have a declining quarter, like the most recent one,
and we actually have to look at our statement and see that we have a smaller aggregate
portfolio value than we did three months ago. Can we stay focused on the total
picture? Can we know that our investment strategy makes sense and there is no
need for panic? Can we feel the fear and stay the course? Can we resist the urge
to make a decision based on our emotions? Can we learn what the six month old already knows and simply feel the emotion?
Not labeling it negative or positive, good or bad.
Unfortunately, many folks do not. A recent study by Dalbar, Inc. found that
the average investor chases market returns. That is they buy high and sell low.
As a result, their study shows that the average equity mutual fund shareholder
earned a paltry 3.51% annually, compared to 12.98% of the S&P 500 index over
the period of 1984 to 2003.
What this tells me is that we use our emotions as a call to action. When the
market is going up, we feel positive emotions of joy, happiness, success, and we buy, buy, buy. When the market
is going down, we feel negative emotions, like fear, anxiety, unhappiness, and we sell, sell, sell.
Buying high and selling low is not a strategy for success! This mayhem is created
when we make decisions based on our feelings. Alternatively, we can realize that
emotions are not a call to action, rather just an opportunity to experience the
fullness of being human. Once we feel the feelings and allow them to pass through
us, we can make an informed analytical decision and take appropriate action.
Going back to the Dalbar, Inc. study, if we translated the results into dollars,
it looks like this:
- If you have invested $10,000 for 20 years and earned the average investor return
of 3.51%, you would have $19,936
- If you earned the average S&P return, you would have $114,824.
- That is quite a price to pay, (over $94,000!) for decisions driven by emotions.
What specifically do you need to do if you find yourself in this buy high and
sell low, emotional roller coaster?
First, get a plan. Take inventory of what you have, where you are and where
you want to go. Develop an investment plan with an asset allocation model, savings
plan, and investment strategy that targets the results you want with a minimum
of risk and volatility.
Second, get more education and/or hire an advisor. Unfortunately, few of us
were lucky enough to get a functional, financial education. And even if we did,
we often need guidance.
Lastly, few of us have any business investing just in one asset class, like the
S&P 500. Instead we need to use the principles of asset allocation and diversification
to smooth out the bumpy ride of investing. These tools don’t guarantee a positive year every year. But history shows that they do lower overall portfolio volatility,
easing the roller coaster ride.
Advisor makes no promises or guarantees about the future return or risk of any
individual security, asset class, or the Portfolio. Historical performance does
not guarantee future performance.
Internal control. Not your everyday topic. Yet the lack of internal control
over the assets and liabilities of your business can give you nightmares.
Public companies are spending millions on improving their internal control systems
thanks to the Sarbanes-Oxley Act. Most agree that the new regulations go beyond
cost benefit.
While private companies are not faced with government mandated regulation, there
are simple things that can and should be done to make sure your money stays in
your pocket. As for the cost benefit, if you have ever had a dishonest employee
whose hand was in the till, you know the feeling of wishing you had acted sooner.
Having a system of controls protects your honest employees as well. If their
responsibility is too broad or far-reaching, and the till comes up short through
no fault of theirs, you may have put them in a difficult situation.
Here are some questions to consider:
- Do you have a system of internal control, whether written or not?
- Is the system being followed?
- Are the roles in your accounting and administrative department set up so that
more than one person controls a function from beginning to end? Are there checks
and balances?
- Have you ever tested the integrity of your electronic data?
- Who has signature authority over your checks? Do you use a signature stamp? How
is it controlled?
- Who has access to your accounts electronically? What are your processes for
safeguarding your accounts and insuring that disbursements are only for authorized
purchases?
- Do you use a budget? Are budget variances investigated?
- What is your electronic security policy? What systems are in place for data
storage and recovery?
- How easily is data altered in your accounting system?
- Are your employees bonded?
- How are your assets tracked and secured?
If you can’t answer these questions, or aren’t sure of the answers, an internal
control review could be helpful. Call Danine Gier to discuss your situation at
859-331-7755.
