Posted By Kaplan Financial Education
Updated: January 25, 2018
Did you know that most equity mutual fund investors tend to underperform the S&P 500? This includes investors who seek out and utilize the help of financial advisors. It’s true. The annual performance of the S&P between 1995 and 2014 was 9.85% while the average performance of an equity fund investor was just 5.19%. The biggest explanation, by far, for investor return being so much lower than the S&P is bad investor behavior, as saving and investing behavior account for 87% of portfolio growth.
Emotions have a lot to do with financial decision-making. When we get emotional, our bodies want us to respond very quickly, and snap decisions are usually wrong.
It's when we don't realize we are getting angry that we tend to make poor decisions or go against our core values and beliefs. The brain is hardwired to reflex before it reflects. An emotional response takes 12 milliseconds while a cognitive response takes 40 milliseconds. This is good if you are trying to escape a burning building, but it poses challenges if you are making investment decisions.
The relationship of investor performance to the S&P 500 and our emotional and psychological behavior is important to share with clients and prospects. This information can help them to understand the importance of selecting a financial advisor who will coach and advise them to handle their emotions in an appropriate way when making financial decisions.
Emotional intelligence is recognizing what we are feeling in the moment and being able to differentiate between our emotions.
For example, let's say you get a call from your child's school, and you find out he has been given an out-of-school suspension. Immediately, you feel your breathing become more rapid, and you start rubbing your forehead. If you notice these reactions and understand that they are a result of the fact that you are upset about the situation, you are using emotional intelligence.
Emotional competence is managing our emotions. It is the ability to stay focused on a goal in the face of competing emotions. It is also the capacity to create alignment between your goals, actions, and values. Emotional competence is the application of our emotional intelligence.
In thinking about the last scenario, you might recognize that you are getting upset about your child's suspension, which as we said, would show emotional intelligence. However, if you don't do anything to manage those emotions, or you let yourself follow a path where those emotions take you to an undesirable behavior, you would be showing emotional incompetence. Emotional competence is being able to successfully manage our emotions once we are able to recognize them. Being emotionally competent would require you to take a course of action that would have the best outcome.
When we get emotional due to outside stressors, our brains actually shut off our ability to think logically and coherently. When we are cognitively impaired, the following happens:
All of these reactions will negatively impact our ability to think logically and act rationally, so our first important step is to learn how to calm ourselves down and bring ourselves out of that emotional state. We can then begin to think rationally again.
So what can you do to become emotionally competent? What will make the difference in your life and the lives of your clients to lessen stress and help you improve decision-making?
Interested in improving your emotional and moral competencies in more depth? Enroll in Kaplan’s Behavioral Financial Advice program and learn how to be more self-aware in times of high stress, identify your top values and apply them to daily decisions, and how to pass these techniques along to your clients.