Understanding Emotional Investing

Behavioral Finance: Understanding Emotional Investing

As advisors, we respect how important our clients’ emotions are. Acknowledging that investing isn’t just about the numbers, charts or forecasts – that our emotions are part of what drives our behavior and comfort level with investing can be very helpful.

Let’s be honest. As markets rise and fall, as investors we all experience a pattern of emotions. It’s human nature. Awareness of these emotions and how we respond can help you prepare for and recognize some common behavioral biases.

Emotional:
  1. Regret: Fear of taking action due to regret of previous mistakes or failures
  2. Loss aversion: you want to avoid the feeling of regret so you avoid making a choice.  Some studies say that a loss has twice the effect on us emotionally as a win.* Think of it this way: Losing $500 on a bet has the same emotional impact as winning $1,000.
  3. Overconfidence: being overly confident in an outcome
Cognitive:
  1. Anchoring or Confirmation Bias: We all like to be proven right! Our bias to this behavior makes it more likely to look for information that supports your idea about an investment than to seek out information that contradicts it.
  2. Selective memory: tendency to remember positive outcomes over negative outcomes
  3. Herding: As humans, we are often influenced by the actions of others, especially when emotions run high. Herding, or following what everyone else is doing can lead to “buy high, sell low”.
No one is immune to these biases. We are hardwired this way. We know that the obvious strategy – don’t get emotional – doesn’t work. So, here are a few tactics you can try:
  • Enact a waiting period. Emotions can make any decision seem urgent. Have you ever made yourself wait to respond to a situation you are frustrated about?  Sometimes, a little time (and calmness) can help our thinking.
  • Consider your time horizon. We often have multiple financial goals: short-term, immediate, and long-term. Dividing your portfolio and investment strategy accordingly can help.
  • Limit over checking. Checking account balances all the time can trigger bias and drive bad decision making. Instead, have a plan that’s in synch with your time horizon and risk tolerance and stick to it.
  • Seek professional advice. Working with a financial advisor to develop a comprehensive plan can help you manage your potential biases. 
Investing shouldn’t be a fight or flight activity. It is as much about psychology as it is about financial knowledge. By recognizing emotional patterns and staying disciplined, you can avoid costly mistakes and make decisions that support your long-term financial goals.

Remember: Patience and perspective are the investor’s best tools. Stay focused, stay informed, and let time work in your favor.
 
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 
 
*Kahneman, D., & Tversky, A. (1979). "Prospect Theory: An Analysis of Decision under Risk." Econometrica, 47(2), 263-291.
 
This material was prepared by Nathan Wyatt for the Investment Service Center’s use.
 
ART Tracking #: 697370-01-02