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Investment Prudence

By Adam Baley

The stock market sparked quite a fright the afternoon of May 6, 2010, when in a matter of minutes, the Dow Jones Industrial Average plunged about 1,000 points – the steepest intraday plummet ever.

Fear is an emotion through which imprudent investors might be tempted to make impulsive decisions.

For athletes, in-game decisions often are made in the blink of an eye and driven by emotion.  For example, a football quarterback needs to make a split-second decision to throw to one of four covered receivers just before a defensive lineman sacks him for a loss.  His choice is based more on gut feeling than analysis, more on instinct than investigation.

Emotions and intuition might occasionally come in handy to a trained and seasoned quarterback, but they often lead investors astray.

When the market rises, emotions like greed can overpower prudent determinations of what we reason things may be worth.  When markets fall, as they did that May day, fearful emotions can prompt us to make knee-jerk reactions.

After experiencing a steep drop in the market and reacting impulsively, investors often share the same sentiment with me, “I’ll get back in when I feel better about stocks.” In other words: “I’ll get back in when the market is higher.”

Allowing emotions to steer investment decisions causes investors to get out when they feel bad and get in when they feel good.  Feelings mislead many into selling low and buying high.

As investors, we must learn to leave our emotions at the door.

To make prudent investment decisions, we ought to act less like a quarterback and more like a farmer.

A farmer considering purchasing a plot of neighboring land approaches the decision sensibly and plans on cultivating the land as long as his family owns the farm.  He will consider how fertile the soil is, how many crops he can sow and how much income the land would likely generate for his family.

The farmer is not thinking: “How much will the farm be worth tomorrow?”  It would be absurd to think that if the farmer bought the land in the morning, he would consider what price it could fetch if he sold it in the afternoon.

Unfortunately, this is how many approach investing: How much do I have today and what might it be worth tomorrow?

Does that sound like you, regularly checking the TV and Internet to get daily or even hourly prices?  Such behavior can lead investors into making emotional, short-term decisions based on an arbitrary value at inconsequential points in time.

Like the football player, a novice investor tends to make decisions in the blink of an eye, relying on what feels right.

Successful, long-term investing is not a series of short-term decisions based on how you feel at the moment but a continuous focus on value you receive over a lifetime.  After all, investing is not a game. Successful investment decisions play out over decades, not 60 minutes on a Sunday afternoon.

Adam Baley is a registered representative and a registered paraplanner licensed in Wisconsin for life, health and accident insurance.

initially posted May 10, 2010

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