Beware of Emotional Investing

February 20, 2020

 

     One of the most dangerous conditions in investing happens to be a very natural human action. People like to buy when the market is at the peak due to the drive of positive emotions like excitement, optimism, and euphoria. Buying is viewed as a positive action linked to positive emotion. “I want to be a part of the run” and “I don’t want to miss this opportunity” are very common phrases used by investors during peaking market conditions. Another interesting point is that investors have been known to add to investment accounts and contribute more to retirement plans more during peaking markets driven by the same positive emotions. A peaking market is the point of maximum financial risk to long-term financial goals. 

     Likewise, the opposite effect happens and is equally as dangerous. People like to sell when the market is at the bottom due to the drive of negative emotions like anxiety, fear, and panic. Selling is viewed as a negative action linked to negative emotions.  “I want out of this free-fall” and “I am scared to stay in any longer” are very common phrases used by investors during bottoming market conditions. Another interesting point is that investors are known to remove money from investment accounts and stop contributing to retirement plans during bottoming markets driven by the same negative emotions. Identical to a peaking market, a bottoming market is the point of maximum financial risk to long-term financial goals.

     Research conducted by Dr. Daniel Kahneman, one of the founding fathers of behavioral economics and the only psychologist to ever win the Nobel Prize for Economics, suggests that when faced with uncertainty, investors tend to make decisions based on their emotions and subjective experiences not on logic or objective reality. He is noted for saying, “the more emotional the event is, the less sensible people are”.1

 

How do you avoid emotional investing?

  1. Don’t fall prey to the media. The media, often times, over hypes markets conditions in both peaking and bottoming markets. Successful investors use the news for information not for decision making.
  2. Be careful not to “follow the herd”. Wanting to be a part of the herd is a natural feeling, but the herd could be running straight off a cliff.
  3. Remove personal feelings from choosing your investments. After all, they do not have feelings for you! 

The key is to remain objective and not to overreact.

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     With the goal of growing net worth, an investor has to remove emotion from the decision-making process when investing.  The old investing principle of “buy low and sell high” still prevails to achieve long term financial goals. There are objective principles like asset allocation, systematic investing and diversification that can help minimize that volatility in a portfolio.  Discipline to remain objective during volatile markets is critical because acting emotional will be counterproductive. Knowing your portfolio and how it interacts with different markets is also essential to weathering turbulent times.

     One of the greatest values that an investment manager can offer a client is remaining objective during turbulent markets and being willing to buy in bottoming markets seeking opportunity.  Building a trusted relationship with a financial professional might prove beneficial along the journey to achieving your financial goals and growing your net worth.

 

 

Bobby Lumpkin
Managing Partner, Capital Investment Services
Financial Advisor, RJFS

 

1Gathered from Emotions and your money: 5 potentially costly mistakes that your financial professional can help you avoid by AIG. https://www-1012.aig.com/research-planning/investor-education/investing-emotions/break-the-cycle-of-emotional-investing.aspx

Any opinions are those of Bobby Lumpkin and not necessarily those of Raymond James. This material is being provided for information purposes only. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

 

 

 

 

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