Emotions have a sneaky way of taking over your investment thinking. Emotional investing clouds your judgment and lead you to act in ways that are counterproductive to your financial success. Instead, investments should be evaluated on their merit. Here are 7 of the top emotions that hijack our thoughts, leading to poor decision making around investing, and what you can do to avoid them in the future.
1. Feeling Left Out
Chatter at cocktail parties, family events or media reports can make it seem like everyone else is getting rich. You can also hear tips from a friend, neighbor, relative, co-worker or even a stranger that can make you feel like you are the only one that is not making loads of money on a great new thing. This was a common scenario during the dot-com bubble of the late 1990s as well as near the height of the financial crisis in late 2007. We’re beginning to see a resurgence of this now in some areas. Many refer to this as FOMO, or the fear of missing out. This can lead down a dangerous path without diversification in other parts of your portfolio.
2. Greed
It’s an intense desire to acquire or possess. Feeling that it is possible to get something for nothing is one of the strongest triggers for greed. There is an almost irresistible tendency for people to think they have “lucked out” and stumbled into an opportunity of a lifetime. While this might be the case, most of the time it is not.
3. Desperation
It’s a state of hopelessness leading to rashness. This feeling can set in when people have made unfortunate financial mistakes or have just been impacted by a bad economy. Some people try to bounce back by assuming an unsafe amount of risk. This approach rarely works as higher risk can lead to even greater losses.
4. Fear
It can immobilize people into stagnant patterns. Fearful investors avoid getting involved in the market because it lacks certain security from losses. However, the inability to accept some risk due to fear can greatly diminish your investment returns. As we referenced in our first emotion, fear can also manifest in performance chasing. In an attempt to avoid any loss at all, people will react to the slightest drop in price by selling and transferring the proceeds to a recent top performer; therefore, missing out on the bulk of the appreciation. Individual investors are not the only group susceptible to this, as 401k plan decision-makers fall victim to this strategy in adjusting investment choices within plans at the wrong times based in large part on past performance.
5. Attachment
This refers to a personal allegiance or loyalty to an investment without proper analysis. This attachment can impair your ability to construct a well-diversified portfolio. Beware if you find yourself saying “I’ll never sell that because…”
- My great grandfather bought that stock in 1912
- I worked a long time for this company and I owe them
- I have used this product for years
6. Pride
Pride and investing are the equivalent of oil and water. Being too prideful can stop you from being able to admit when you are wrong and need to correct your mistake. No one buys investments expecting them to underperform, however, sometimes this is inevitable. The research firm for the American Funds, Capital Research Group, states “We are very careful when making changes because we expect to be wrong 1/3 of the time.”
When a firm with an excellent track record expects to be wrong 1/3 of the time, it is clear that a certain amount of humble detachment is appropriate and necessary for successful investing. In addition, it is important to recognize when it is appropriate to seek assistance from experts.
7. Fairness
People like to feel as though they are being treated fairly, and that desire extends to their investments as well. Unfortunately, fairness is something not easily measured. Investments can be both beneficial to you as an individual and seem like the treatment was not equal to all. Investments are not a zero-sum game where someone has to be a winner and a loser. People generally make mistakes when they are unwilling to accept the fact that the world is not fair. Individuals should not base their decisions on forcing the issue of fairness when it is in conflict with what is best for them.
How to Avoid Emotional Investing
Emotions can cloud your judgment, resulting in poor investments that don’t pan out. Fortunately, there are a number of steps you can take to safeguard your investments and protect yourself from irresponsible, emotional investing.
Establish Financial Goals
Investments aside, how many times have you done something, based on emotion, that went against your original plan, and how many times did it backfire? By establishing financial goals and a long-term plan to achieve them, you are creating the framework necessary to steer your financial investments in the right direction. While this can seem daunting at first, working with an established financial advisor can simplify this process and allow you to focus on what’s important.
Stay Diversified
Whether it’s the fear of missing out or the fear of branching out, establishing a diversified investment strategy can help you focus your investment efforts where they need to be. This can save those who are prone to going all-in on the newest trend and can help others who are afraid of investing outside of their comfort zone due to risk.
Use the News as an Informational Source Only
We are all guilty of getting overly excited (or fearful) from something we watched on the news. While the news — be it radio, internet, tv or print — is great for information, you shouldn’t make impulsive decisions based on what you read or hear. Instead, use the information along with other resources to make educated investment decisions that align with your financial goals and strategy.
Discipline is Required
Don’t let these seven compromising emotions derail your financial journey. Having an investment strategy and discipline is vital to avoid getting whipsawed by emotional investing. See if any of your core investment beliefs line up with our methodology. Knowing your limitations and putting boundaries in place before these feelings surface, may just be one of the best decisions you make with your long-term savings.
