Emotional Investing has consistently been shown by professional investment managers, as well as behavioral psychologists, to be inappropriate or to not result in overall investment success. Most individuals realize that emotions can get in the way of prudent investing. Arguably, however, it is probably one of the drivers of many investment decisions commonly made.
In a study conducted several years ago by Stanford University, a number of individuals were given the same amount of money and asked to participate in a 20 round gambling game. A portion of the participants, however, were individuals who had suffered some type of brain injury that prevented them from feeling emotion. Intellectually the individuals were equivalent in every way. As the game progressed, the logical response was to bet the same amount each time, which is what the control group did. The other individuals would choose to not bet on certain rounds due to fear of loss. At the end of the game the control group consistently ended up with more money than those who could feel emotion.
In an interesting article by Bryan Keller, in Seeking Alpha: The Cost of Emotional Investing, it was shown that even when investors chose a fund to stick with over several years that they did not always match the performance of the fund as an individual. Many times assets were withdrawn or moved, perhaps returned. Sometimes assets were not contributed as promised and many other factors influenced overall performance.
Just yesterday, financial advisors Tom and John Mills, wrote an article published in the Napa Valley Register that discussed emotional investing. They stated that an investor who place $1,000 in an S&P 500 Fund twenty years ago would have $5,000 while those who followed the crowd generally ended up with $2,000 (according to a Dalbar survey). They quoted the book, “The Art of Investing and Portfolio Management” by Ron Cordes, Brian O’Toole and Richard Steiny in discussing the “cycle of emotion”. The essence is that fear and greed are investors’ worst enemies.
According to the book cited above, when the market starts an upswing after a decline, investors are full of hope. After it matures they become greedy. After the market peaks, fear sets in and they begin selling.
Sound like the current potential scenario? Some tips from the various advisors cited above include:
-The key is discipline. Be void of emotions regarding investments.
-Don’t chase performance.
-Keep your portfolio balanced and diversified.
-Don’t overweight in any particular stock or asset class.
-Be conscientious regarding your lifetime needs.
It’s probably time for investors to begin to assess their own emotional feelings about investing. Be sure that it is the right time for you to buy or sell based on logic, not on emotion.