Using Precommitment Strategies to Avoid Emotional Investing
Are emotions your enemy when making decisions about your money? There are steps you can take today to help keep yourself from acting in ways that ultimately sabotage your financial future.
Key Takeaways
Studies show that certain feelings can pop up, such as greed or fear of loss, when making decisions about money.
By automating good decisions today, you can prevent emotions from interfering with your financial best interests.
Precommitment strategies are a commitment to yourself—tomorrow’s success may depend on the careful steps you take today.
Understanding Emotional Investing and Its Impact
It’s human nature for emotions to sometimes influence our decisions about money, according to behavioral investing experts. For instance, when faced with the pressure of the day’s news or market performance, it’s tempting to react and change strategy.
In strong markets, you may hear stories about people making money from trending investments. The fear of missing out (FOMO) on high returns can lead to making risky purchases.
On the other hand, market declines can induce fear of losing everything and prompt selling at low prices to “cut” losses—but it actually may lock in losses on investments that had the potential to recover.
Your reaction to today’s market environment may be impacted by when you started investing. Learn how availability bias could lead to misjudging risk.
Avoiding Investment Mistakes With Precommitment Strategies
How do you keep emotions from interfering with your financial best interests? First, it’s important to recognize them. Then you can commit to actions today that can help prevent your future self from acting in ways that sabotage your goals. These actions are known as precommitment strategies.
Do you pay bills online automatically each month? What about making automatic contributions from your paycheck to a savings account or 401(k) plan? These are precommitment strategies—good money decisions that you don’t have to remake each month.
There are other ways you can use precommitment strategies to your advantage. For instance, consider setting up an annual appointment with yourself or a financial advisor to review your portfolio. Knowing you have this commitment to formally assess your situation may make impulsive, short-term decisions less likely.
Keep Emotions in Check With a Financial Professional
A financial advisor who understands the structure of your investment plan and long-term goals is a valuable resource to help keep yourself on track. Circumstances change, and it can be beneficial to have someone by your side to discuss whether the plan still fits your objectives and risk tolerance.
An advisor also can help develop precommitment strategies that make it less likely you’re pulled off course by an emotional decision. For instance, you can agree to a phone call if the market moves up or down 10% or you want to move your money to a hot new investment trend.
Precommitment Strategies Are a Commitment to Yourself
No matter how much willpower you think you have, precommitment strategies can help you avoid temptation in the first place. It doesn’t mean your plan is set in stone. However, precommitment strategies let you make more thoughtful decisions when emotions have settled down.
Tomorrow’s success may depend on the careful steps you take today.
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Khanemen, Daniel; Sibony, Olivier; and Sunstein, Cass R. (2021). Noise: A Flaw in Human Judgment. Generic.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.