Emotions and Investing

masksToday’s post will be about emotions and how you should put them aside when making investment decisions. Investment is about numbers, percentages, ratios and other, factual  things. There should be no place for emotions here. At the same time we continuously meet with emotional impacts that can affect our investment decisions. They can come from many sources: analyst up- or downgrades,  the new super investing opportunity we hear from our neighbor, headlines of financial news, or the result of the presidential elections. These impacts can make you buy or sell assets, while such decisions should not be based on them.  Let’s demonstrate this with an example:

You’re invited to play a game (watch out, it involves some gambling element:) ).  There’s a box with 200 pictures of different people. 60% of them have a criminal record, the rest don’t.  You need to pick pictures from the box one by one and you need to tell whether the person on the picture has a criminal record or not.  Every time you need to bet 1 euro and if you guessed right, you double your bet, otherwise you lose it.

The tactic you should follow is pretty simple:  you should always bet on that the person on the picture has a criminal record. By this, you’re guaranteed to win at the end of the game, even if in 40% of the cases you lose your bet.

Now let’s say you pick the following picture:

happy-man
Or this one:

smiling-woman
They look nice people, right? Would you change your bet…? Many people would get overruled by their emotion and make a decision that doesn’t make sense based on the pure numbers. By making such decisions, they are actually reducing their chances to win in this game.

The above analogy can be very true for the stock market, especially if you do index investing. History proves that besides of financial crises, world wars, natural disasters, the stock market is only going up on a long term.  Still, many people can lose fortunes on emotion based investment decisions.

The best thing you can do is to do your own research, make your long term investment strategy and stick to it. This is exactly what I’ve also done in the series of Searching for the Perfect Portfolio.  You can find those articles here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Summary

I recommend doing the same for yourself; better if you write it down so you can always look it up in the future. Does it contain things like “Depending on when does the FED/ECB raises the interest rate or depending on who will be the next president of the USA, I’ll do this or that”?  If no, then all these events are nothing more than a noise for you. Stick to your plan!

I wish successful and emotion free investment to all of you out there!

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9 thoughts on “Emotions and Investing

  1. Financial Panther

    Avoiding emotions is so important to long term investing. This is why automating your investing is so important. By doing that, you really take away a lot of the emotion that can naturally come into your decision making process.

    Reply
  2. Mustard Seed Money

    I am a huge fan of dollar cost averaging that takes the emotions of investing. Automatically setting up buying times throughout the month/year allows me to not think about timing the market and a lot of the stress involved with the volatility of the market. That’s not to say I don’t get excited/nervous when the market is moving in a direction but I’m getting better about not jumping off the roller coaster 🙂

    Reply
  3. DivHut

    We are all human which means emotion will always have some degree of influence in your decision. The key is to keep it in check as much as possible and simply follow the facts and numbers that we see today to base our investment choices. I consider myself a long term investor and was able to keep my emotion in check during 2008/09 when my entire portfolio was deep in the red. I just stuck with my plan to keep investing every month as I always have no matter where the market is or “predicted” to go. It’s all about discipline.

    Reply
    1. Roadrunner Post author

      Being at the stock market during 2008/09 must have given you great experience. Well done for surviving the storm! I don’t know when the next will come, but I know what I’ll do then: same as now.

      Reply
  4. Dividend Diplomats

    Great freaking article. It is hard to keep emotion out because of the human element of it all, as Divhut said. Everyone wants to think they are the best investor and understand the emotional swings of the market based on past experiences. But the best thing you can do is drown the noise out, stick to your stock screener, and purchase a quality stocks if it crosses your pre-determined metrics. Don’t try to predict and time the market. You said it best..stick to your plan and follow that plan to prosperity!

    Bert

    Reply
    1. Roadrunner Post author

      Thanks for the comment Bert, I agree with you. Once you made your decision and bought a stock, don’t let temporary price moves affect your choice, as long as the main fundamentals remain unchanged.

      Reply
  5. Go Finance Yourself!

    Spot on. Some of the smartest people I’ve worked with have been the worst investors because they let their emotions drive their investment decisions and pull all their money out of the market when someone on the news tells them the world is going to end. They end up selling low and then buying high once they figure out everything is ok and they need to get back into the market.

    Reply

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