Emotions and Investment Decisions
Overcoming your own emotions is the primary factor in the success of your investments.
I teach my students about many factors that effect investments and methods of analytical decision making. Including technical, fundamental, and macro economic factors like currency, trade, markets, politics, social trends, and new technologies, but none of this matters if you can’t control your own emotions.
Your emotions can lead to a variety of bad investment decisions, such as:
[if !supportLists]Selling losing investments – Declines in the financial markets may lead some investors to “cut their losses” by selling investments whose price has declined. A down market is actually a good time to buy investments, not sell. The decision to sell an investment should be made on the fundamentals or price to market comparison. The decision to sell should be viewed exactly the same as the decision to buy.
[if !supportLists]o [endif]Is this investment fundamentally flawed?
[if !supportLists]o [endif]Is this investment overpriced relative to its peers?
[if !supportLists]o [endif]Is there a clearly better investment available at this time?
[if !supportLists]Chasing performance – Don’t be greedy, this is the other end of the emotional spectrum and just as dangerous as fear. Just as one might be motivated by fear of loss, many are motivated by big gains, and the idea of a quick buck. They may pursue “hot” investments, only to be destroyed when the market quickly corrects. Instead of trying to “score” that one big one, you are better off finding good sold investments. Don’t follow the crowd. Avoid using the same source of information as everyone else; the best investments are more often the one that haven’t been discovered by the herd.
[if !supportLists][endif]Stick with your strategy - Don’t focusing on the short-term with your long-term investment strategies. When employing any form of fundamental investing you should establish an investment time frame. This could be range from weeks to decades. For passive investments and long-term fundamental investments you should not focus on daily reports or monthly statements. This might be difficult and you could feel tempted to take action based on these arbitrary snap shots in time. But you need to chart your investment over a numerous periods with a reasonable scale relative to the expected holding time. Don’t overreact to short-term downturns by making hasty “buy” or “sell” decisions. Instead, stick with your strategy.
[if !supportLists]Volatility: Most people think of a “bull market” as the best time to invest and often want to wait for it to start investing. Bull markets are always identified to late, so the real profit potential is from investing in the bear market. Although the greatest opportunity for low risk, high profit investing is in volatile markets. For example let’s assume a market becomes volatile dropping an average of 6% every 60 days and ending the year up 5%. Likely return with a few different strategies:
[if !supportLists]o [endif]Buy and hold: 5%
[if !supportLists]o [endif]Cyclical investing: 23%
[if !supportLists]o [endif]Sector rotation: 27%
[if !supportLists]o [endif]Stock swing trading: 41%
[if !supportLists]o [endif]Note: These are averages for active investors and can be affected by other factors.
[if !supportLists][endif]Considerations: [endif]$10,000 invested in S&P 500 in December 1979, your investment would have grown to more than $426,000 by December 2013. But if you had missed just the 10 best days of the market during that time, your $10,000 would only have grown to less than $206,000 – a difference of about $220,000, according to Ned Davis Research, a leading investment research organization. The best days tend to be at the end of a large downturn.
Emotions are useful in guiding us through many aspects of our lives, but when investing, you’re better off using educated and logical decision making.