There are two parts to the decisions we make. The first part relies on knowledge, fact, logic, and what we would call common sense. The other, relies on other intangible things like emotions, intuition, fear, worry, hope, and feelings generally.
Whenever we are torn between making a decision that splits us between our ‘brain’ and our heart, one has to give way – and logic isn’t always right. Investing is an emotional business. It requires setting asides our hard-earned funds, and the emotions that come with possible losses can lead us to making biased decisions.
An active investor has to deal with a myriad of different emotions as he follows the market and watches the rise and fall (volatility) of his investments. These emotions range from fear/anxiety, investor expectation, overreaction on pieces of information and even stress.
They can be so pronounced that even an experienced investor with a well laid out investment strategy can still fall prey to emotions overriding rational thinking or logic. Here are some elements that propel emotional investing.
Information
Investors typically get information from many sources. They could be mainstream sources like the news or could be entirely based on public speculation. Investors can get lost in the multiple sources of information and make biased decisions.
In fact, because no market has perfect information, the information received would almost always not be credible and will ultimately not matter. Acting on such information and seeing it go wrong would force yet another emotion that can ultimately make the investor completely uninterested in investing altogether – regret.
Another way information can go wrong is when investors try out new investment areas because their friends or family members have tried it and it worked. Great opportunities might be too good to be true as they would ultimately carry more risk than the investor can handle as the basis of their exceptional returns.
Risk
No investor wants to lose money; as such, where an investor notices a downward trend, he or she is sent into a frenzy of panic. Investors need to have risk and their level of risk tolerance in mind before buying into stocks or investing in securities altogether.
Investors who are conscious of the risk factor from the onset can curb the effect of emotional investing by remaining within a comfortable risk threshold. A great way to mitigate the possibility of emotional investing or making biased investment decisions because of the emotions attached to risk, is to seek out ways to mitigate risk.
A properly hedged investment strategy would keep the investor generally relaxed and open to carefully assessing market volatility. Another great idea is to invest only funds you can afford to do without for the longest period.
The moment your investment becomes an important source of personal income, chances are that you would react emotionally to changes in the market.
Investor Expectation
Another reason the investor begins to function emotionally is that his or her expectations do not match the flow of activities in the market. Every investor wants to make money from his or her investment by way of investment growth.
The challenge comes when the investor is fixated on a certain degree of growth based on market indices, timing strategies, trend analysis and other forms of analysis. When things seem to go awry, the investor loses track of the goal and becomes impulsive.
While these are just some of the reasons investors bring emotions into the investing game, emotions cannot be eliminated form investing. In our next post, we would explore specific ways of managing emotions while investing.
