NewburyportNews.com, Newburyport, MA

Business

March 13, 2012

Beware of your financial instincts

For investment markets, the year 2012 has come in like a lamb. So far, they have been meeker and steadier than the hypervolatile 2011.

The year 2012 has also come in like a bull. January alone brought broad stock returns up over 4 percent.

Is your instinct to read promise or doom in the direction of the markets year to date? The analytic part of you will admit, "Past performance is no guarantee of future direction."

But what about how you feel so far, after looking at your statements from the end of January? Is your emotional reaction positive or negative?

The fact is that if you let your emotions and feelings guide your financial decision-making at all, you put yourself and perhaps your family at a disadvantage, if not at serious risk. The best and most recent case for understanding the downfall of those who let their instincts drive their money behavior is Daniel Kahneman's book, "Thinking, Fast and Slow," published last year.

Kahneman, a psychologist and Nobel Laureate in economics, underscores the folly in day trading and the disadvantage in thinking you can pick winning individual stocks.

The standard or classical view of stocks is that their prices are the result of the super-aggregated and rational purchases and sales of thousands of investors studying the same publicly available information. But in reality, far too many individual investors base their investment decisions on their fear of loss and not any well-analyzed market data.

One of the most common mistakes investors make is misreading short-term results. An example of misreading short-term results would be overweighing the significance, if any, in the direction of the markets so far this year.

If you are convinced you have prescient instincts and enjoy the thrill of trading, then create a "play money" account. Keep it separate from your serious money accounts, especially those intended for your retirement and college tuition. For your serious money, think seriously. Exercise appropriate risk-management discipline for the long term. If you don't have the appropriate analytic wherewithal yourself, hire an experienced adviser, not a product salesperson.

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