Investment Strategy and Avoiding Emotional Interference
Plan Ahead to Overcome the Emotional Reactions that can skew prudent Investment Strategy
As humans, we are emotional creatures, and our feelings can have a tremendous impact on our behavior. When it comes to investing, this 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 in particular that can wreak havoc on your investment strategy – if you let them.
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 take 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. 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 arrive.
SEE ALSO: Your Money Story and Your Choices
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, in the end, negatively impacted our personal or business lives. 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.
If 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 need that specific stock and the 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 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 Jim Cramer is fond of saying, “Bears make money, bulls make money, and pigs get slaughtered.”
None of us can entirely overcome our emotional biases. However, we can improve our investment strategy by being more aware of how emotions play a role in our decision-making. Take control of your financial success by only making investment decisions when you’re feeling cool, calm, and rational.