People tend to interpret information differently from one another, which can impact their behavior. How an investor perceives their investment performance, for instance, can play a substantial role in how they react to seeing any fluctuations. To improve their financial decision-making, it is vital that an investor is aware of the perceptions versus the realities of their investment’s performance.
What should investors be conscious of?
There are certain misconceptions around investing that, when addressed, can help investors to better understand the behavior of their investments and make more objective decisions. An important one is understanding the difference between paper gains/losses and realized gains/losses:
– Paper gains and losses: These represent an increase or decrease in the value of an investment that has not been sold. They remain unrealized until an investor decides to sell that investment.
– Realized gains and losses: These occur when an investment is sold for a price higher or lower than its purchase price, leading to actual gains or losses in your capital.
Understanding these two concepts helps you stay on track with your investment plan, rather than being reactive to the daily movements of your investment performance.
The Psychological Impact of Perception
Perception can often dictate people’s decisions and behaviors; likewise, how investors mentally perceive their investment gains or losses can determine their next actions.
For instance, seeing paper losses can be stressful for investors. Reactively selling the investments, after experiencing a paper loss, causes them to become realized. In turn, this leads to more stress as the investment performance is not given a chance to rebound. Conversely, if an investor decides to sell their investments too early after experiencing short-term paper gains, they could miss out on more growth when investing for longer.
The Impact of Perception on Risk Tolerance
Additionally, these perceptions can cause people’s risk tolerance to fluctuate like financial markets. Realizing paper losses can cause investors to be more risk-averse and miss out on potential future rebounds. If they sell too early due to excitement over short-term gains, they may make financial decisions that are riskier in the long term than what they are actually comfortable with.
How to Navigate Investing for the Long Term
Unlike risk tolerance, a person’s long-term goals should not fluctuate; therefore, neither should their long-term investment strategy. Understanding the differences between paper and realized gains/losses leads to:
– Informed Decision-Making: You are better equipped to make informed investment decisions when you differentiate between temporary market movements (paper) and actual gains/losses incurred by selling your investments (realized).
– Emotional Stability: You recognize that paper losses are part of the normal market cycle, ultimately preserving your emotional stability and deterring you from making impulsive decisions driven by fear.
Overall, it is better to make financial decisions for your future based on actual facts, trends, and historical examples, rather than on subjective perceptions. Avoiding these biases allows you to be more objective, taking action based on your long-term objectives and strategies rather than being influenced by external factors. Investing with a platform like SmartWealth, which utilizes a long term, passive investing strategy, can help you manage your own emotional reactions to market fluctuations and make the most of your money over time.