Are You an ‘Emotionally Intelligent’ Investor?

Editor's Note: This story originally appeared on NewRetirement.

Ravee Mehta made a splash in 2012 when he published “The Emotionally Intelligent Investor.”

The premise went against everything anyone learned about investing in the 20th century, like reason being better than emotion and that a few basic principles should guide all investors.

You never want to make an emotional decision with regard to your money. And, you especially don’t want to buy or sell assets based on fear.

However, you can learn to understand emotions and use them — rationally — to your advantage.

We’ve come a long way since the days when investors and economists thought that markets were infallible and made up of purely “rational actors.”

Now there are different strategies for different types of people — each with unique goals and resources.

The Different Types of Intelligence

Since the late 1970s, economists and psychologists have been developing a more complete view of human intelligence. We’re not all made from the same mold, and a person’s strength in one area could become a weakness in a different situation.

In the early 1980s, Harvard psychologist Howard Gardner developed his theory of multiple intelligences to counter the standard view of intelligence in the old IQ tests. A shortlist of Gardner’s types of intelligence includes:

• Visual-Spatial Intelligence. Visual artists and architects excel because of their great visual-spatial intelligence.
• Linguistic-Verbal Intelligence. Writers, teachers and lawyers have this kind of intelligence.
• Logical-Mathematical Intelligence. This is the kind of intelligence people usually associate with financial intelligence, but it’s not necessarily so.
• Bodily-Kinesthetic Intelligence. Builders and people who are good working with their hands have this kind of intelligence.

The other kinds of intelligence are musical intelligence, interpersonal intelligence, intra-personal intelligence and naturalistic intelligence.

What kind of intelligence do you have?

You can take this test to see what kind of Gardner’s intelligence you have.

You might assume that because you have more linguistic-verbal intelligence than logical-mathematical intelligence that you won’t be as good an investor as someone more math-oriented.

But as Ravee Mehta points out in his book, that’s not necessarily true.

The Behavioral Economics Breakthrough

When we discovered there isn’t one mental disposition that makes you a better investor, we also discovered that all people, no matter what kind of intelligence they have, share some biases that trip them up when they’re making financial decisions.

For example, all of us are liable to value what we have more than what we don’t (the endowment effect).

And, the disposition effect may cause us to hold onto under performing investments while selling good investments that we should hold onto.

For a full list of the cognitive biases that can hurt you in retirement, read our article: “Behavioral Finance: 16 Ways to Outsmart Your Brain for More Wealth and a Better Retirement.”

Becoming an Emotionally Intelligent Investor

You can improve your ability to invest and save for retirement with a simple two-step process.

It not easy. As Benjamin Franklin said in his Poor Richard’s Almanac, “There are three things extremely hard: steel, a diamond and to know one’s self.” But it is possible.

The good news is just engaging with step one will automatically make you a more emotionally intelligent investor.

1. The first step: Know yourself

It’s easier said than done, but it can be done. This is where Gardner’s emotional intelligence test comes in: Find out where your strengths are — and your weaknesses.

In a bull market, everyone thinks they’re a genius on par with Warren Buffett, but when the tide goes out (as Buffett says) you find out who’s been swimming naked.

• Acknowledge your biases. Have you held on to an unprofitable investment because the time never seems right to sell it, even though you know it’s a mistake? Let yourself see your biases, and you will overcome them.
• Take your own investing temperature. Investors get burned when they think they can handle a lot of risk and then they lose money. You may thirst after 20% annual returns, but if you’re saving for retirement accept the fact that you also have prepare for downturns.
• Focus on your strengths. Don’t let the many things you do OK get in the way of what you do best. If you have a side hustle that is more enjoyable than your day job, maybe it’s time to switch.

And, learn to recognize emotions

It is one thing to know your emotional strengths and weaknesses. It is quite another to be able to recognize what you are feeling.

Psychology Today says that, “An emotionally intelligent individual is both highly conscious of his or her own emotional states, even negativity — frustration, sadness, or something more subtle — and able to identify and manage them.”

Emotions are designed to make us react — quickly. There is an evolutionary purpose for feelings. Fear can keep you safe. Anger activates flight or fight. Frustration triggers action.

However, reacting to market data and making financial decisions purely on emotion is misguided.

The financial markets to do not require an immediate emotional response. They are not a tiger or great white shark in the wild!

2. The second step: Make an investment plan and stick to it

Too often we hear someone tell us their investments are through the roof, and we think we need that for ourselves. But following the crowd is a recipe for losses.

Make a plan that makes you confront your biases and leverages your strengths.

Use this checklist to help you develop your plan. If you can say “yes” to all of the following in good conscience, you are on your way to becoming an emotionally intelligent investor.

1. I am confident about why I’m investing and what my long-term goals are.
2. I am invested in my future.
3. I am NOT invested for short-term gains.
4. I will not disinvest to avoid short-term losses.
5. I seek diversification in my investments so my future doesn’t depend on a single source.
6. I have a plan and an investment timeline, and I will NOT stray from it.
7. If I do decide to make changes to my plan, I will seek advice from as many sources as possible before I make the change.

Or, create a full investment policy statement. And, if you know that you are prone to emotional decisions, you may want to work with a financial advisor who can help keep you on the right track.

3. Finally, know your plan for long-term financial well-being

Best yet, make sure you have created a comprehensive retirement plan for a secure future. Understanding your plan for long-term financial wellness is critical to making smart decisions today!