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| Fear is one of the most primal human emotions and plays a huge role in emotional investing. |
Investing is an emotional experience. With so much at stake, it can be an emotional roller coaster to watch the stock market gyrate from day to day.
Investors are often torn between their guts and their heads. While there’s nothing inherently wrong with consulting your emotions when making purchasing decisions, stock buyers do need to beware of relying too heavily on their guts. Bank runs, flash crashes and stock market surges are just some of the ways in which emotions can impact the market for the worse.
Why does this type of emotional investing happen and how can investors avoid both the euphoric and depressive investment traps? Read on for some tips on how to keep an even keel - and keep your investments on track.
1. Bad Timing
The lag between when an event occurs and when it is reported is what typically causes investors to lose money. The media will report a bull market only once it has already hit; unless the trend continues, stocks will retract in upcoming periods.
Investors, influenced by the reports, often choose these times of premium valuations to build up their portfolios. It is worrisome when the daily stock market report leads off the mainstream news because it creates a buzz and investors make decisions based on "opinions" that are often outdated. Market uncertainty creates fear and brings about an atmosphere of emotional investing.
2. Fear
Fear is one of the most primal human emotions and plays a huge role in emotional investing.
“I find that fear is probably the most detrimental emotion,” said Bruce Ailion, a real estate marketing expert. “It might be the fear that prevents making a good investment. It might be the fear that causes an exit at the first sign of trouble that prevents realizing the full profit of the investment.”
3. Hope
Just as being too fearful can jeopardize your investment success, being overly hopeful is problematic. Hope can turn negative when it inflates expectations. Whether you’re a brand-new investor or one with years of experience, being too optimistic can lead you to take on too much risk with the idea of scoring a big payout.
Further, people who are too hopeful often experience something called recency bias, in which they assume that what has happened recently will continue to occur in the future.
4. Stubbornness
Believing in yourself is one thing, but stubbornness rarely pays off in the world of investing. In fact, stubbornness often inspires investors to purchase a stock that isn’t ideal or stay with a stock that has already shown signs of dropping.
“Part of the problem people have with giving up hope is that they’d have to admit they were wrong,” said Kirk. “If the investor were to sell it at a loss, they’re admitting they made a bad decision. Worse, a bad financial decision. Admitting this is very tough for people. In reality, often it’s best to cut your losses and move on.”
It’s good to have faith in yourself and your abilities. However, if you stubbornly refuse to listen to reason, you could quickly put your investments — and your money — at risk.
5. Write Down Your Rebalancing Plan
If you don’t rebalance your portfolio, it will drift over time from your plan. The drift can become significant during extremely good or extremely bad markets when our emotions can get the better of us. Rather than waiting until this difficult times to decide when to rebalance, come up with a plan now and commit it to writing. It can be as simple as rebalancing once or twice a year.
Rebalancing will force you to sell asset classes that have risen in value and buy others that have fallen in value. It’s exactly what we should be doing, but it can be difficult. Who wants to sell stocks when they are going up and up, only to buy miserly bonds A written rebalancing plan puts this decision on autopilot, taking our emotions out of the equation.
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