Let’s say I offered you a choice of a sure win of $50 or, on the toss of a coin, a chance to win $100 or nothing. While the probabilistic outcome is the same, you would likely choose the guaranteed $50 according to scientific studies. After all, it’s a sure thing. Next, I offer you a sure loss of $50 or, on the toss of a coin, the chance to lose $100 or lose nothing at all, again with the same probabilistic outcome. What would you pick? Most people would gamble at losing nothing despite an equal chance of losing twice as much because they have loss aversion and thus tend to view the possibility of recouping a loss as more important than the possibility of a greater gain.

How do you act when you suffer a loss in your investments? How often do you hold on to a losing stock in hopes that the price rebounds? No one likes to admit they are wrong, so investors often hold on to some stocks much longer than they should.

On the opposite end, there is herd mentality. For example, when the market is down 33% from the high, and everyone is selling. While selling locks in a loss, many investors cave in to fear and sell at the bottom of the market—often only to regret their decision and want to invest the following day when stocks are up 10%. When you lose 33%, it takes nearly a 50% gain to return to even. By the time the market is up 10%, you’ve already missed a good portion of the gain needed.

Emotions are something every investor must reconcile, as no one cares more about your money than you. That’s why you’re more likely to take a chance to lose nothing and why you might want to sell out during a recession. More common is the tendency to buy when market prices are high, as was most evident during the Tech Bubble of 1999. Investors rushed to buy stocks after they had appreciated to unjustifiable levels in hopes that the trend would never end.

If you are following the Ten Year Rule, you should have 10 years of liquidity needs in fixed-income investments, which are less affected by the volatility of the stock market. If you are working with an adviser, he can reassure you that you don’t need to sell stocks to raise cash. You have money set aside for the next few years regardless of what the market does. Likewise, when the market is up 30%, your adviser will recommend you sell stocks to fulfill your 10-year liquidity needs.

Fulfilling your liquidity needs doesn’t mean taking the full $100,000 you need to live on each of the next 10 years and putting $1 million in fixed investments. There is a good bit of planning involved to determine how much you are receiving from Social Security, rental income or other sources of passive income, and dividends and interest. The shortfall is your liquidity need, the amount you must sell in your stock portfolio and re-invest in bonds.

For investors to be successful, they must first overcome their emotional reactions; otherwise, they will end up selling low and buying high—the exact opposite of what they set out to do. Working with a financial adviser and developing a comprehensive financial plan is a helpful step toward successful investing. It won’t stop you from calling your adviser when the market is down 33% and panic sets in, but it does allow you to have someone on your side to talk you out of your emotional decisions and save you from yourself.

Support Local Journalism

Now, more than ever, residents need trustworthy reporting—but good journalism isn’t free. Please support us by purchasing a digital subscription. Your subscription will allow you unlimited access to important local news stories. Our mission is to keep our community informed and we appreciate your support.

William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial and a co-host on Atlanta’s longest running, most respected financial talk radio show “Money Talks” airing Saturdays at 10 a.m. on AM 920 The Answer. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

22
0
0
0
0

(0) comments

Welcome to the discussion.

Keep it Clean. Please avoid obscene, vulgar, lewd, racist or sexually-oriented language.
PLEASE TURN OFF YOUR CAPS LOCK.
Don't Threaten. Threats of harming another person will not be tolerated.
Be Truthful. Don't knowingly lie about anyone or anything.
Be Nice. No racism, sexism or any sort of -ism that is degrading to another person.
Be Proactive. Use the 'Report' link on each comment to let us know of abusive posts.
Share with Us. We'd love to hear eyewitness accounts, the history behind an article.