In last week’s blog we talked about the idea of off-farm investing and concentration risk. The objective of investing is simple: buy low, sell high. Unfortunately, accomplishing that objective is not so simple. Why is that? Well, investors are human and humans have emotions. Here are some common ways that emotions work against investors:
1. Doing What Feels Good
Here’s an interesting fact: Researchers have shown that the pain humans feel from a loss is roughly twice as powerful as the joy we feel from a gain. This has a huge impact on how investors behave. For example, investors will often hold on to a bad investment, increasing their risk, simply to avoid the sting of realizing the loss. Similarly, investments seem to be the only thing people don’t want to buy more of when they’re on sale. It feels much better to buy when things are going up (and getting more expensive). This is not rational behavior, but it’s human behavior.
So what should we do? Build your investment portfolio in connection with a comprehensive financial plan. A planning-based approach can give you confidence that you won’t outlive your money. This financial peace of mind helps you make smart, non-emotional decisions about money when the stakes are high.
2. Over-Investing in What We Know
Humans are the ultimate creatures of habit. We find comfort in doing what we’ve always done. Unfortunately, this trait is not helpful in investing. One of the most important foundations of successful investing is diversification because no asset goes up all the time.
So what should we do? Build an all-weather portfolio with a variety of investments.
-Spread some of your wealth to assets outside of land and other Ag holdings. Build holdings in low-cost stock mutual funds, bonds and non-Ag real estate.
-Max out annual contributions to IRAs and retirement plans (profit sharing, 401(k), etc.).
-Diversify your retirement income streams outside of farm rental income.
Taken together, these strategies will create a smoother ride for your investments and help insulate your financial future from being too dependent on any single asset.
3. It’ll Always Be This Way
Another way emotions work against investors is a concept called “recency bias.” Humans tend to believe the future will be just like the recent past. If an investment has done poorly recently, we think it’ll never turn around and vice versa. As a result, investors often make long-term decisions based on short-term trends instead of keeping a steady hand.
So what should we do? Take the long view and tune out the noise. The 24/7 news cycle makes the good seem better and the bad seem worse than they really are. Fortunately, farmers are accustomed to being long-term minded. Many have owned their land for multiple generations and throughout multiple ag cycles. It’s helpful to take the same approach to investments outside of ag. With a diversified portfolio that matches your risk tolerance you can confidently navigate the waves of uncertainty.
Investing is simple, but not easy. Keeping these factors in mind should help you make sound decisions when it matters most.
If this article hits home with you and you’d like to chat about your own investing approach feel free to contact me at jpeacock@BDFLLC.com.
Investments involve risk and past performance may not be indicative of future results. Balasa Dinverno Foltz LLC (BDF) investment and wealth management strategy recommendations may not be profitable, suitable or equal historical performance. BDF’s current written disclosure statement discussing advisory services and fees is available for review at www.BDFLLC.com or upon request.
The opinions of the author are not necessarily those of Farm Futures or Penton Agriculture.