Dealing with Investing Emotions

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I cited the results from the Dalbar study when I wrote about why I don’t time the market.  My conclusion – our emotions are the greatest enemy to successful investing.  For your investing plan to be successful it needs to be personalized. Thus, successful investing is not only about returns, but about following a predetermined plan that gives you the greatest possibility to reach a predetermined goal.

Photo by Bransorem

Because you are the greatest enemy to successful investing, I suggest you automate your investing.  You should do the same thing on a regular basis regardless of market conditions.  Every investing institution that I know of will allow you to have funds regularly withdrawn from an account and automatically invested.  The less you need to do something, remember something, or initiate something, the more likely it is that the plan will be successful.

Did you know if you invest as I describe above you use an investing strategy called ‘dollar cost averaging’?  It is a strategy that ensures you are buying less shares when market conditions are high and more shares when market conditions are low, but most importantly, it makes sure you are always buying.

This is the best way for beginners to invest.  Here is a quick introductory article to Dollar Cost Averaging.

The only thing you need to remember is to continue following the plan regardless of market conditions.

Here is how I would suggest you implement a dollar cost averaging strategy (assuming you have already decided how you will invest (i.e. Roth IRA, 401K, …) and what you will invest in (specific bonds, mutual funds, and stocks).  I am assuming these funds would be used for retirement.

  1. Determine how much you can (need to) invest.  The Charles Schwab organization recommends the following:
  2. Age when saving starts % of salary to save each year

    20-something                             10%-15%

    30-something                             15%-25%

    Early 40s                                    25%-35%

    45 and older                               OUCH!  See Play the Percentages: 45 and Older

Your plan is more likely to succeed the higher the percentage you save.  Again in an effort to automate the process and remove your emotions from the equation, apply a percentage of your pay towards retirement and pay that percentage even when you get a raise.

2.     Contact your broker or human resource representative.  Tell them you want to set up automated payments.  They will send you some paper work and you simply tell them what day you want the funds withdrawn from your account or pay and where you want the funds invested.

3.     Review performance one or two times a year.  This review does not need to be a huge ordeal.  Simply find out what the closest index is to your fund type.  This simply tells you for the type of investment it is if it is performing at, below, or above market levels.  If a investment lags for a year or more you might consider making an adjustment (assuming you are not investing in funds that charge start up fees called ‘load funds’).

4.     Adjust your investment choices and your investment amount when necessary.

5.     Continue investing for the rest of your life.

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