Investment Strategy and Avoiding Emotional Interference
Plan Ahead to Overcome Emotional Reactions that Can Skew Prudent Investment StrategyKathy Longo, CFP®, CAP®, CDFA Wednesday, 06 October 2021
I write a lot about the interconnectedness of money and emotions, and I also talk about it frequently on my Flourish Financially podcast. That’s because we humans are emotional creatures, and our feelings can have a tremendous impact on our behavior. Of course, that includes financial decision-making, which permeates many aspects of our lives. When it comes to investing, in particular, the natural highs and lows of the stock market can have emotional effects. If we’re not careful, these emotions can inhibit our ability to make sound financial judgments. In fact, many poor investment decisions have been made by investors who became too emotional and let their behavioral biases overrun their rational thoughts.
For this reason, it’s crucial to understand how emotion can interfere with your investment success. We all go through life with various ups and downs and hiccups along the way. This can cause fear and uncertainty – both fertile fields for emotional financial decision-making.
Below we will discuss three emotional biases that can wreak havoc on your investment strategy – if you let them.
Emotional Bias #1: Investing Decisions Based on Fear
Fear serves many purposes in our lives, and it’s true that sometimes it keeps us safe and secure in an unpredictable world. However, fear also keeps us from taking advantage of opportunities that could benefit us. Consider 2009, when big household names such as General Electric and Wells Fargo, two traditionally expensive and well-performing investments, were available for pennies on the dollar. This was, quite possibly, the best buying opportunity most investors had ever seen. Why, then, did the majority of people let it pass them by rather than taking advantage of historic opportunities? The answer is fear, and this example is a perfect illustration of how it acts as an enemy of investing. Logically, most educated investors know that the best time to invest is when others are afraid to. However, most of us fall easily into the traps fear sets in our investment psyches. Simply being aware of this can, in and of itself, help you mitigate the effects of fear on your own investment strategy – and it might allow you to capitalize on opportunities as they arise.
Emotional Bias #2: Anger/Frustration-Based Investing Choices
Anger is one of the most powerful emotions human beings can feel, and I’m sure many of us can recount instances of making decisions out of anger that negatively impacted our personal or business lives in the end. If you’ve ever sold an underperforming investment out of frustration only to watch it surge days later, you understand how impactful anger can be in our lives and on our finances. Anger and frustration override our rational thought; they can make us abandon excellent strategies or overreact to market fluctuations. Investors who have the most consistent success are those who remember to remain calm while making investment decisions, and who always look past emotions to the facts of a situation.
Emotional Bias #3: When Greed and FOMO Undermine Logic
There are two common pitfalls for investors spurred by greed. One is the fear of missing out, or “FOMO.” If there is a hot new investment that people have been making a lot of money on, the impulse is to jump on that trend, as well. However, if the price has already skyrocketed, you may ultimately end up paying way too much for it. The urge to own that specific stock, and the related FOMO, can lead you down a costly path. Another pitfall is holding onto a specific type of investment and even buying more of it because you might have done well with it in the past. Don’t let the past history of the investment cloud your judgment about when it’s time to let it go; you should always have an exit point for every investment you make. Following these guidelines can keep you from falling into the traps of investor greed. There is no investment that you absolutely need. As straight-talking financial analyst and CNBC host, Jim Cramer, is fond of saying, “Bears make money, bulls make money, and pigs get slaughtered.”
Final Thoughts on Investing and Emotions
Even when we work intentionally to overcome our emotional biases, none of us can entirely remove emotional interference from our financial decision-making. However, we can improve our investment strategy by being more aware of how emotions play a role in the investment choices we make. Take control of your financial success by only making investment decisions when you’re feeling cool, calm, and rational.
Interested in more content about investing and emotions? Check out our very own Jay Pluimer’s Flourish Insights podcast, especially Episode 35: What Biases Influence Your Investment Decisions?
About the Author
Kathy Longo brings over 25 years of expertise and experience to Flourish Wealth Management. Kathy is wholly dedicated to improving the life of each client and finds joy in making complex matters simple and easy to understand. She excels at asking the right questions, uncovering new possibilities and implementing the most advantageous strategies for success. Playing such a pivotal role in her clients’ lives remains an honor and a privilege. After earning a degree in Financial Planning and Counseling from Purdue University, she began her career at a small firm in Palatine, Illinois where she worked directly with clients while learning to build a viable, client-centric business. Over the years, she gained extensive knowledge and wisdom working as a wealth manager, financial planner, firm manager and business owner at notable, various sized companies in both Chicago and Minneapolis.