Everyone makes choices about money nearly every day – how to earn, spend, and save. Our decisions often depend on a variety of internal and external influences. We seek control when there is daily noise of bad news that seems like it will never end, and with managing personal finances, it frequently leads to impulsive behavior.
Rational and Irrational Behaviors
Supposedly, if you could learn more about the cause and effect of your money decisions, and what contributes to them, you could improve your sense of financial security. Pinpointing behaviors as either rational or irrational in the middle of the storm comes hard; nonetheless, a hypothetical scenario could help explain.
Let’s say in month A, the S&P 500 was down 5%. If sensitive to market moves, maybe you reacted to the decline and sold big – a flight perhaps revealed as irrational, given the market rallies and jumps in the first two weeks of the next month B. However, by the end of month B, if there were continued losses, selling may have seemed brilliant, almost clairvoyant.
In this scenario, you showed loss aversion – one of many money behaviors. Psychologically, people perceive losses (or declines in value of an investment) as much as 2½ times more impactful than gains of a similar size. Watch your investment drop $1,000 and you feel more than twice as bad as you might feel good about a gain of $1,000.
Loss Aversion Impact
Most people are loss averse, and this bias toward avoiding loss over achieving equivalent gains can lead to impulsive behavior that doesn’t always lead to positive outcomes, especially in the short term. Reallocating too conservatively may not allow for the growth potential needed to achieve goals. Selling when market prices decline (as in the scenario), removes the potential for gains when the stocks rebound. Equally adverse is not being open to more suitable investment options that may be available.
Our Wealth Advisors utilize a sophisticated technological tool called Riskalyze to take clients through a series of hypothetical scenarios that demonstrates and quantifies risk tolerance. Investment strategies are then designed with the benefit of this understanding, and aligned within an individual’s specific comfort level.
Your Investment Strategy
Markets are complex and make investing both fascinating and, at times, maddening. Engaging our experience and expertise to customize portfolios based on research and designed to consider market volatility, risk and time horizons, serves as a foundation for long-term financial assurance.
Your broader financial plan drives your investment strategy, not the other way around. Know that your portfolio is managed to support your desired spending rate in retirement, or to make tuition payments, fund a wedding, cover health-care costs, and so on.
At Biondo Investment Advisors, it’s important we know you are comfortable with your plan, your investment strategy and your ability to handle market fluctuations. Therefore, we encourage reassessing your risk level with your Wealth Advisor and discussing a prudent approach to reallocation. As your financial lifecycle changes, it’s one of the ways to be proactive, so that radical decisions do not derail the pursuit of your financial goals.
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