Making Difficult Investing Choices During Difficult Times

“Men nearly always follow the tracks made by others and proceed in their affairs by imitation.”  - Niccolo Machiavelli

Investment decisions are among the most important life choices a person can make. They may determine where your children will be able to go to college, when you’ll be able to retire, or what kind of lifestyle you’ll enjoy after you retire.

Unfortunately, these are also some of the most difficult choices a person can make. This is especially true now as we work our way through arguably the worst financial crisis of our lifetime. In order to make sound decisions, we need to be aware of our own psychological blind spots. These can lead us to make persistently poor financial choices—errors that over time can do significant damage to our portfolios.

Traditional financial theory assumes all investment decisions are made rationally, based on the best available information. However, it’s not always easy to reconcile financial theory with financial reality. Investors often appear determined to ignore the fundamentals, both in bidding stock prices up and slamming them back down again.

The desire to experience a positive outcome often prompts us to imitate the actions and behaviors of others.  This refers to “herd behavior,” the tendency for people to mimic the actions of a larger group of investors.  Recent examples of this include the money that poured into real estate in 2005 and the late 1990s technology bubble.  Before this, it was the same story for energy stocks in the early 1980s, following skyrocketing oil prices in 1979.  And now?  The herd is putting money into CDs and other short-term cash equivalents.  We know how this story will likely end.

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