Over the last three decades, most investors have averaged a measly 3.69% return, while the S&P 500 had an 11.11% average annual return.
The good news, however, is that much of this discrepancy depends on factors that are entirely within your control: your emotions.
While I wholeheartedly endorse learning about the markets and finances, the truth is that the average investor is fairly limited in regards to this. There are thousands, if not millions, of factors impacting the stock market, and no one person can reasonably expect to know every detail about finances. Emotions, on the other hand, are something that we all can control and master with some elbow grease, and Stanford studies show that they are one of the biggest influencers of investment success.
In my decades of experience helping individuals reach their financial goals, I can attest that mastering your EI (emotional intelligence) when it comes to finances is just as (if not more important than) boosting your IQ and investing knowledge. In the often counterintuitive world of investing, your emotions can lead you to act irrationally and out of your best interests, regardless of any investing knowledge.
Without further ado, here are some ways you can boost your emotional intelligence in investing, and ultimately, your success.
Recognize you’re human, but emotions often lead you away from success.
Warren Buffett once said, “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”
We often attribute our emotions to successful choices; after all, how often have you heard the phrase, "follow your gut?" However, when it comes to investing for the long term to reach your goals, our feelings often prove counterintuitive. Buffett's phrase holds so much water because some of our strongest emotions – fear and greed – tempt us to sell when our investments are low, and buy when our investments are high. Take Brexit, for instance, when the Dow slid 900 points in just two days. Following your fearful emotions would lead you to sell your investments at a low, and ultimately become sorely disappointed when the Dow recently reached all-time record highs.
The first and biggest step toward boosting your emotional intelligence about investing is to recognize that although your feelings may be valid (it is your wealth on the line, after all), they aren't necessarily the indicators of a correct decision.
Focus on the data.
While fear can occasionally steer us from danger, it often has the exact opposite effect when it comes to the stock market. Since we notice a potential loss far more than a win, anytime the stock market goes down, we’re naturally inclined to be fearful and want to sell our investments, even though they are likely to recover eventually.
The good news, however, is that you can keep your fear (and corresponding impulsive behaviors) in check by looking at the data.
The recent Donald Trump election victory (a highly emotional time for many, stock market aside) serves as a prime example. When the news of his win broke, Dow Futures slid nearly 800 points, as many investors responded with fear and uncertainty about the shocking results. If we look back at the data, however, it’s clear that past presidential elections (no matter how shocking they have been) and investor fear have always been eventually followed by a new high in the markets.
Use an advisor to keep your emotions in check.
When your own wealth and nest egg is fluctuating in value, it might be difficult to make rational decisions, no matter how many tips you read. After all, your wealth represents much more than numbers; it ties into important life goals, like your retirement or funding your children’s education.
One benefit to using an advisor in emotional situations is that they can be an impartial third party who has experience navigating the markets. They can not only provide a level head, but they can also offer tools (like forecasting your portfolio’s future performance) that can help keep your decision-making rational.
A word of caution: Not all advisors are created equal. You may want to consider a fiduciary advisor, which means they're legally obliged to act in your best interest. On the other hand, many advisors who are legally brokers are held to a lower suitability standard (which means the investment only needs to be “appropriate” for a client).
Try mindful adjustments.
No matter how much effort you put in, it’s impossible to completely eliminate emotions from the equation. Although everyone has to stomach some degree of risk and volatility to be a successful investor, a periodic gut check is always a smart idea. After all, these concepts will only serve you in practice, not theory.
During times when your emotions are tested beyond their limits in investing, I’d recommend a financial check-in – either with an advisor or yourself. You can take a look at your risk tolerance and see how it pairs with your long-term investing goals and horizons. Many times, you’ll probably want to maintain your current allocation, but even a 5% allocation adjustment into less-volatile investments (like bonds) can quell highly emotional investors.
These check-ins should ideally happen at least once a year, but if you’ve been tempted to act on your emotions, a sooner one may be in order.
The bottom line: Emotional thinking is important in investing.
Much of your long-term investing success doesn’t rely on knowing the latest hot stock or complex calculations; it’s simple emotional thinking that can have the biggest impact. While you can’t eliminate your emotions from the equation (especially when it comes to money), you can take steps today to recognize them and boost your EQ.
