How to avoid emotional investing decisions
Part I of AWM’s InvestHER series (Article also published on LinkedIn)
How can you be SMART and avoid making emotional investing decisions that end up losing you money or opportunities? Create a personal Investment Policy Statement (IPS).
An IPS is a document that's created to keep a portfolio manager and a client on the same page. Most big companies and nonprofit entities have an Investment Policy Statement. Some retail investors (regular people) have them too, although many financial advisors are getting away from this practice. Here are some ideas to think about how you can draft your own IPS. The idea is to have guidelines and purpose for your investing strategies and avoid making emotional investing decisions.
Step 1: What's the point? What's NOT the point?
Why are you investing? Are you investing because your friend or the news told you it's "hot" right now to invest? Do you have extra cash? Are you trying to set up a strategy for retirement? Are you saving for your child's education? Are you trying to "stick it to the man" by buying and selling stocks you heard about on a Reddit forum?
Start with your objectives. Setting goals is the fun part! You can dream of retiring at age 55, buying a vacation home, living your best life, whatever it is. Each goal will be allocated differently. Meaning, the investments you use to fund your retirement 20+ years away will look very different from the assets you use to put a down payment on a home in 2-3 years, for example. Make note of these varying time horizons. They will be important for your IPS.
Step 2: It's all about you!
How well do you know yourself? Let's talk about your risk profile? Everyone is ok if their investment doubles, of course. But, are you still ok if your investment goes down by 5%? What if it goes down by 20%? Or 50%? Finding your comfort level with volatility is step one.
Being invested in the market is like riding a rollercoaster. There are many highs and many lows. You can mitigate these highs and lows by trading risk for return and smooth out your ride a little bit. What you don't want to do is get scared and sell low after buying high, an emotional decision! This is a very common mistake that amateur investors make. Sometimes they do this because they don't have a plan and don't have a guideline for investing. They probably also haven't already been through a previous market crash like 2008 or March 2020. By selling your investment when the market is going down, you might be missing out on the biggest comeback of your life! Don't let this be you.
How much of your net worth are you investing? Is this investment a small portion of your total financial picture? Or is this investment a big chunk or your portfolio? You wouldn't want to go to Vegas and bet everything you own on one game of roulette, so don't put 100% of your portfolio into a risky investment and expect it to all be there in a year.
Step 3: Allocation, or where to put your money
You'll need to sort your money first by taxes.
Non-taxable money: Non-taxable investments are usually your retirement accounts, your 401k, your Traditional IRA, a kids' 529 account, etc. What you put into your nontaxable accounts will look different from the rest. Depending on how long you have until you start using this money, you'll want to make sure your risk return is appropriate for the length of time you have until you start withdrawing. For example, if you have more than 10 years until retirement, you want to make sure that your investments in your retirement accounts are at least keeping up with inflation. Ideally you want to invest where you can earn higher returns and continue closing the gap between what you need to retire and what you have to retire. If you are closer than 10 years until retirement, congratulations! You've done the hard work of saving and investing. Now you should be thinking about protecting this account from the volatility in the market by investing in "safer" assets.
Taxable money: You've already paid taxes on this money. Again, start with your goals for this investment. Are you saving for a new car or deck for your home? Is this just extra cash that you are saving for a rainy day? How much liquid cash do you need on hand at all times in case of an emergency? How much money are you stashing away for your future?
Step 4: Restrictions. Do you have any investing restrictions?
Do you have any moral or ethical restrictions? Back in the day, they used to be called "sin stocks". Some people didn't want to invest in tobacco or alcohol or oil companies. Today we use the term, "ESG" which stands for Environmental, Social and Governance. We can screen companies that are big players in this space and support a more sustainable world.
Do you have any legal, tax or international restrictions? Make sure you are clear on these guidelines because you don't want to get into any sort of trouble with your investments.
Remember, an IPS is a set of guidelines for you to refer back to when you have questions about what's going on in the market or you begin to feel emotional about your portfolio. The IPS is written by your rational brain. You can build a portfolio that expounds upon these rules you set, but always remember these guidelines to keep yourself in check.
At Audax Wealth Management, we build SMART Portfolios that help you reach your goals in life. Ask us about how we can help you build your custom IPS and portfolio. Send an email to hello@audaxwealth.com to get started.
Until next time, be well.
