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On Making Rational Decisions

If you think about any decision you ever made, would you say you made a logical decision and backed it up with emotion, or made an emotional decision and backed it up with logic.  Think about the decision to buy a candy bar.  We all know it is not healthy, full of sugar and gives our bodies very little value; yet we still want it.  Emotionally, we want that sweet taste, that hint of chocolate, regardless of the lack of nutritional value it really has.  Then comes the logic; you went to the gym so you deserve it; you haven't had one in a while; you'll make up for it by having a salad tonight.  It's not to say that having the candy bar is bad and you should never have one.  Rather, this illustrates that even the seemingly simplest decision is initiated from an emotional state and fortified with logic.

If we really think about it, we can convince ourselves that any of our decisions "make sense" with logic.  So what does this have to do with financial planning, investments or retirement?  It is important to understand that all of our decisions are first made based on emotion; ergo all of your investment decisions are based on emotion.  Not so much the decision of what to invest in (logic), but rather the decision to invest in the first place (emotion).  Why do we invest and to what end? To allow our money to make money so that we may afford the lifestyle that we ultimately desire.

This is an important distinction as many investors allow their desire for retirement, i.e. their emotions, to override the logical part of the equation, what to invest in.  They chase returns, jumping in and out of the markets at the worse times.  The problem is that the greatest opportunities for us to invest are in direct conflict with our natural emotions.  Below you will find a chart that illustrates the emotions that we all go through as our investments ebb and flow.  You'll notice that the greatest risk occurs when we're feeling euphoria; "This is going to keep going up!"  Conversely, the point of maximum financial opportunity is during the darkest times, when the pundits tell us that we'll "never recover."

Visual representation of the Cycle of Market Emotions

The ultimate take away is to understand that all of our decisions are initiated from our emotions and backed up with logic.  When it comes to investing, don't let your emotions take over and cause you to suffer from an ultimately poor decision.  Working with a trusted advisor can be a great way to reduce the possibility of such an outcome.