Market observers long have detected that investment decisions have an emotional component. Consequently, many of the mistakes that investors tend to make are a result of basic human psychology.

Research by behavioral psychologists suggests that most individuals feel twice the pain over a financial loss as they do the pleasure of an equivalent gain. In their classic 1979 study, Prospect Theory: An Analysis of Decision Making Under Risk, Daniel Kahneman and Amos Tversky found that people make different choices in equivalent situations, depending upon whether the choices are framed within the context of gain or of loss. When study participants were told that they had been given $1,000 and were asked to choose a sure gain of $500 or a 50% chance to gain $1,000 and a 50% chance to gain nothing, 84% chose the sure gain. Alternately, when they were told that they had been given $2,000 and were asked to choose a sure loss of $500 or a 50% chance to lose $1,000 and a 50% chance to lose nothing, 69% chose the second option. The choices that were offered to each group were identical in terms of the net cash amounts that the individual could receive; yet the phrasing of the questions caused the choices to be interpreted differently.

Common Conflicts

Most people don't have the time or inclination to delve deeply into the field of behavioral finance. But they can look inward and examine their own reactions to investment. Here are the more common emotional reactions:

• Failing to act or procrastinating does allow one to avoid unpleasant thoughts and outcomes, but it ultimately provides no solutions.
• Hitting the panic button can lead an investor to follow dubious advice or to chase the latest trend without any sound reason.
• Holding on too long to one's investments, even when it seems logical to let go, is such a common emotion that psychotherapists have given it a name - "divestiture anxiety."

Taking a Rational Approach to Investing

If you see your own reactions in any of those described, it's time to review your portfolio and turn some of these negative emotions into positive action.

1. Be clear about what you are doing. Can you easily summarize your investment strategy on paper? Your portfolio should reflect who you are, your goals, investing time frame and tolerance for risk. Developing and articulating your strategy will deter you from making changes to it solely based upon how the market rises and falls.
2. Use the right tools to help you find success. Asset allocation - spreading your dollars among the basic investment categories, among stocks, bonds and cash equivalents - is an organized, systematic approach to building and maintaining a portfolio. Diversifying your holding within each asset class is important as well. For instance, within the equity portion of your portfolio, you may want to consider large-, mid- or small-capitalization stocks; choose a mix of stocks that yield dividends and those that are growth stocks with little likelihood of significant dividends. You may want to take a look at investing in the equities of companies outside of the U.S.
3. Be vigilant.Review your investment choices regularly and make the necessary adjustments accordingly. You may need to rebalance your portfolio when your holdings in a particular portion of your portfolio exceed the original allocation target that you have set. Family and personal circumstances also may prompt you to review your investment strategy.

Don't Go It Alone

There are opportunities to be found out there, and we can help you find them. The professionals at Southern Community Wealth Management can provide unbiased, objective financial advice and help you to formulate an investment strategy that incorporates both your long- and short-term goals, tailored specifically to your needs and concerns. For more information and options, call us at (336) 794-7832.