Fear and greed take the blame for most financial mistakes, but emotional investing has nothing over ignorance and stupidity.
By Adriana Reyneri
Lots of research dollars have gone toward studying the notorious “cycle of emotional investing,” which you can see illustrated in a nifty graphic on the Northwestern Mutual website. The cycle begins with optimism, rises up through excitement and thrill and peaks at euphoria. You know what’s coming, don’t you? Emotional investors eventually flounder in the troughs of despondency and depression, which leave them with just about enough money for coffee and a donut at the local Dunkin’s.
Some caffeine and sugar later, emotionally and financially strung-out investors experience hope, which leads to relief, which leads us back to optimism. Those of you familiar with the cycle may have noticed that I left out anxiety, denial, fear, desperation, panic and capitulation. I figured the average American investor is sick of all these negative feelings - particularly fear, desperation and panic.
Emotional investing takes place on a daily basis. In a May survey by Millionaire Corner, 42 percent of participants admitted to making an investment decision based “solely on emotion.” And when 42 percent of the people admit to doing something, it’s likely that a lot more are actually doing it. It was no great surprise to learn (gender bias showing) that men were much more likely than women to succumb to irrational investment decisions, 49 percent versus 33 percent, respectively. Nor was it a revelation that investors rated the success of their emotion-based decisions as 44 on a scale of 100 - an “F’ in my book.
Fear, desperation and panic also take on a whole new level of significance in today’s turbulent markets. I’ve been to Six Flags. I get the difference between the Whizzer and Vertical Velocity rides. I know that fear and panic can get you into a whole lot more trouble when the market drops by 500 points in just a few hours.
The problem with the emotional investing theory is that - like the insanity plea - it’s much abused. Too many rueful investors claim they were out of their minds with fear or greed and leave buried the root causes of their bad investing. To illustrate, I'll tell you about a "friend" who listened to her teenage son back in 2009. He lifted his face from a big bowl of milk and Cheerios and, talking over the morning’s financial news, recommended buying stock in General Motors. He reasoned the federal government “would never allow GM to go bankrupt.”
Granted the stock was selling for 85 cents a share at the time, but it would have been quicker and more efficient to flush the money right down the toilet rather than to invest in GM that fateful spring. A few months later the company filed for Chapter 11 and earned the nickname “Government Motors.” Still, as rueful and abashed as my “friend” feels now, she really can’t blame fear and greed for her folly. Emotions really had nothing to do with it - unless the feelings list now includes laziness and stupidity.
On the whole investors appear to face more of a threat from their own ignorance and negligence than they do from their emotions. It may sound harsh, but this unsettling realization offers hope. We can channel Warren Buffet, enlist the help of a trusted financial advisor, engage with the plethora of planning tools on the Internet and slowly develop the investor discipline necessary to build and maintain wealth. Fear and emotion - with a little panic thrown in - may even speed us on our way to a methodical savings plan and balanced investment portfolio
So, the next time you decide to jump into an investment without checking the depth of the water, remember the sad tale of Government Motors. Do your homework before putting your money to the test. Keep in mind there are no guarantees. Even investors who always do their homework occasionally fail.