OCEAN CITY — When it comes to investing, it’s never prudent to run from your emotions. Rather, use them to ensure that your decision making is in line with your personal goals.
In an experiment conducted in 2011 by researchers at Stanford University, 50 participants with a median age of 20 viewed digital avatars of themselves on a large screen. Some participants saw images of themselves at their current age, while others saw images of their future selves, aged nearly half a century via a process called immersive virtual reality. According to the research, participants who saw their future images allocated more than twice as much to their retirement accounts as participants who saw only youthful images.
This type of study is part of a growing field known as behavioral finance, which “creates a starting point for a collaborative conversation about who you are as an investor,” says Michael Liersch, director of behavioral economics for Merrill Lynch Global Wealth Management. The idea is to make the investor’s appetite for risk and other behavioral traits a more integral part of the planning process.
There are three key components that go into understanding your investment personality. The first is your comfort with, and willingness to take, investment risk — also known as your “investment mindset.” The second are the elements and solutions that can be included in an investment strategy to help you stay invested — your “investment approach.” Finally, there are the reasons you’re investing, and whom you’d like your investment to benefit — your “investment purpose.”
Needless to say, different types of investors have different needs, and often different preconceptions. These will be affected by many elements, including their assets, their experience with the markets and their age. In that sense, better understanding who you really are as an investor can help you develop a financial strategy that better serves your needs and that you’re more likely to stick with in the long run.
Young investors who are hesitant to wade into the markets can more clearly determine their relationship to risk by first considering their long-term objectives, and then devising an investment strategy.
Enhancing one’s awareness of how different strategies fit together to achieve personal goals can help.
“Income solutions like annuities shouldn’t be viewed as investments,” Laster says. “They should be viewed as insurance. You’re hedging longevity risk, a key concern for retirees. A useful metaphor is thinking about cars. You could take a luxury car that has a smooth ride but gets less mileage. That’s the trade-off. A thoughtful approach to allocating assets can help you feel comfortable and assured in retirement but may reduce your upside potential.”
In the end, better understanding yourself as an investor isn’t necessarily meant to change your attitudes or behaviors. By looking at the kind of reactions you tend to have and your relative comfort with investing, as well as taking into account the purpose of your investments, the behavioral approach allows you to accommodate both your emotional needs and potentially your financial goals.
Indeed, understanding why we make the choices we do is crucial to investors at any stage in the game, for their present and future selves.
(The writer is a Merrill Lynch Wealth Management Advisor and can be reached at 410-213-8520.)