How to Keep Your Emotions out of Investing Decisions

Behavioral finance research has shown time and again that our biases and emotions often cause significant damage to our investment portfolios. Here are 4 points-to-ponder as you review your long-term plan to avoid making an emotional mistake.
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By Dennis Stearns, CFP

Stories are increasing of pre-retirees and retirees going all to cash, similar to late 2008 and 2009 in the depths of the Great Recession. Except now it seems more logical since many stocks have recovered much of their pandemic losses. Is this a good idea? My answer is maybe, but only with a well thought out game plan.

Dennis Stearns

Dennis Streans

We all know the age-old advice of investing objectively, keeping emotions out of the equation. Behavioral finance research has shown time and again that our biases and emotions often cause significant damage to our investment portfolios. Everyone wants to buy low and sell high, but investors are still reversing that strategy due to heightened emotions during periods of fear or greed.

What issues of our day are skewing our emotional mindsets? Here’s a short list:

1. The pandemic – COVID-19 stress is showing up everywhere. Life isn’t normal, and frustrations and anger towards the reality it may not get back to normal soon are creating tremendous anxiety, spilling over into investment decisions. One of our clients felt they were mostly immune to this stress until their daughter was scheduling a traditional wedding for August. The soon to be son-in-law’s mother insisted on a “normal” wedding with limited distancing and masks optional. The anxiety level in this family is reaching a fever pitch.

Health concerns among the most vulnerable populations (seniors, those with compromised immune systems, heart problems or diabetic issues, etc.) are still sky-high even though death rates are less onerous than at the beginning of the pandemic due to better treatment techniques.

The uneven economic re-opening in the U.S., followed by accelerating infection rates and many states backpedaling on re-opening plans, has added to the frustration levels of many who simply want this pandemic mess to be over.

The “rest of the story” – If you own a bar, restaurant, cruise ship, or Disneyworld, you’ve got a business problem for a while. If you’re a shareholder in a public company the news is better – recovery of some lost revenues and the tried and true expense reduction companies do during a recession bode well for profit recovery.

The unemployment level among the college-educated is under 7%, not far off the long-term average, which is why consumer spending has rebounded nicely in the age of Amazon. And efforts on treatments and vaccines are at unprecedented levels, with good news surfacing on accelerated vaccine trials.

Near-term risk to most stocks is low-moderate.

2. Stretched valuations – Investors are worried that valuations, from price-to-earnings ratios to free cash flow to price-to-sales ratios, are above pre-COVID levels for many S&P 500 companies. Perhaps a bigger issue is that five stocks (Amazon, Alphabet/Google, Apple, Facebook and Microsoft) have made up the majority of index gains in the pandemic and over the last five years. This chart is incredible – five stocks leading the advance over the other 495 stocks of the S&P 500 index:

Top 5 market performers in S&P500

The “rest of the story” – Some traditional valuation metrics are less reliable coming out of a recession. The Great Recession of 2008-2009 demonstrated that. Still, stock valuations are worrisome in the middle of a pandemic that won’t be over soon. I believe we are in the deployment stage of the techno-industrial revolution, which historically means many technology stocks who are surfing the tech-enabling wave should have premium pricing. The problem is we’re now in price territory that is way beyond “premium” for some of the big tech stocks.

Near-term risk to tech stocks is moderate-high.

Near-term risk to most stocks is low-moderate.

3. The November elections – Investors have begun to worry about what happens if the Democrats take the white house and the senate in November. Predictit.org and other credible surveys, revamped after the survey fiascos of 2016, suggest this “blue wave” is better than 50/50 odds. Having control in all three branches of government would make it likely that the tax changes in 2017 would roll back to 2012 levels, or worse.

For investors, rolling back corporate tax rates makes “stretched” stock valuations move into “really stretched” territory.

The “rest of the story” - The good news is we wouldn’t be at 1999 “irrational exuberance” valuations but still priced for lots of good news with little room for bad news from the pandemic, China relations, or a host of other bubbling issues.

Near-term risk to most stocks is low-moderate.

4. Rising government debt – Worries about rising government debt are rampant given massive relief packages to deal with the pandemic induced recession. Worries range from crowding out of key government expense areas in future years to rising interest rates and inflation.

The “rest of the story” – Consider the massive government stimulus as re-filling a lake where the water level dropped 30% from a drought. Flooding, or in this case inflation pressures, are not a major issue.

Government debt should be compared to the size of the economy and economic growth – a single debt figure tells us nothing about risks in the future. This “debt-to-GDP” comparison is rising into more dangerous territory were it not for the U.S. still being the world’s currency of choice. Yes, this is still true despite the U.S. pulling back from engagement in many parts of the world.

Deflationary pressures are currently higher than inflationary ones, so rising inflation and interest rates are likely not a major concern in the next few years.

Near-term risk to most stocks is none – low.

The bottom line – There are lots of things to worry about, which is par for the course in today’s world. I do believe the potential threats to some areas of the stock market are greater than normal, which suggests some investors should use “defensive re-balancing,” moving to target allocations with more defense than normal. Sound rebalancing techniques aren’t just strategic; this is also a good time to rebalance growth and value stock allocations.

Going all to cash is a radical move that needs careful consideration for pre-retirees and retirees. This is a great time to freshen up your long-term plan and avoid making an emotional mistake. Have a chat with your uncle, best friend, or advisor— anyone who has good common sense, above-average investing knowledge, and a balanced view of the world.

About the author: Dennis Stearns, CFP®

Dennis Stearns is an author, TEDx speaker on the Future of Jobs, financial advisor and President of Stearns Financial Group, an independent wealth management firm recognized by Citywire RIA as a Future 50 firm. More tools and resources – including a free Fumbleocity Quiz – are available at www.StearnsFinancial.com.