Investing can be complicated. Not only do you have to worry about price fluctuations and bid-ask spreads, you’re also concerned about whether to buy, when to buy and when to sell. At the same time, investing is more than strategic analysis and trading mechanics. After all, investors are still human and emotions creep into our investment decisions far too often.
Investors are not computers. We are human beings with families, mortgages, career pressures and a host of other emotional baggage that affects our decisions. We are subject to the confusing whims of the market. The distress of plummeting prices, the thrill of soaring profits, and the doldrums of congestion can all influence how we invest our hard-earned savings. Our emotions can get the better of us and change our investing choices.
A New York University study demonstrated this problem in a more controlled setting.
“In a clever series of experiments, Balcetis and Dunning show that people reliably misperceive how far away an object is based on how much they desire it. That is, more desirable objects appear closer. In one study, the researchers had people sit across the table from a full bottle of water and then had them either eat pretzels or drink water from an eight-ounce glass. After being shown a one-inch line as a reference, the participants were then asked to estimate how many inches separated them from the bottle of water. Consistently, the thirsty participants perceived the water bottle as being closer than did the quenched participants.”
Just as thirst affected the laboratory test subjects, so also the need for gain or the allure of owning a “winner” can affect investors. Our desire for investment success can make it easier to hold a “winning” stock way beyond its expiration date or keep that “loser” in a feeble hope that it will bounce. The glass of water seems much closer when we’re thirsty. Who hasn’t made an investment decision and a week later said to himself, “What was I thinking?” This is the emotional aspect of investing. And it’s a colossal issue.
Here are a few tips to help slow down the emotional roller coaster. Most experts agree that success comes more easily when they keep their emotions out of their investment decisions.
1. “Investor’s Got to Know Their Limitations.”
Some investors focus 95% of their time and energy on what to buy and when to buy it, and 5% on everything else. While this might be a slight exaggeration, the lesson still applies. Selling is often the hardest decision an investor has to make. When buying a security, decide beforehand on your expected profit margin and time horizon. Conversely, be honest with yourself about the maximum loss you can tolerate. Use tools like stop-loss or limit orders to help you manage this range and be resolute in these decisions.
2. “You’ve Got Mail.”
The world is flatter then ever. With 24/7 information and social media, investors are plugged in to other opinions more then ever. Greater access to information can help, but don’t feel the need to run your portfolio like you run your Facebook or Twitter accounts. Not every bit of information that comes through your media lense automatically deserves a response. The proper filters are imperative to understanding what is relevant and what is just white noise. Be careful and don’t allow the satisfaction of being part of the new media age drive your portfolio decisions.
3. “Why So Serious?”
Investing is definitely serious business, but keep your head about you. Typically, more then half of a self-directed investor’s decisions will end up in the red. This doesn’t mean success is impossible; the earnings from your “winners” can overcome your “losers” if managed correctly. Don’t let the market get inside your head. Successful investors stick to a disciplined and dispassionate approach, even in volatile extremes. Let your investment process drive your decisions, not the exhilaration of the market.
4. “Houston, We Have A Problem”
Finally, if your emotions still get the better of you when making investment decisions, it may be time to consider other solutions. You – and your portfolio – may be happier letting someone else take the wheel. This is one reason the investment management industry exists. Good managers rely on a dispassionate perspective to steer their selections. Their focus will be on the investment process, which allows them to leave that emotional investment baggage at home. Letting a professional worry about returns can help you keep your sanity.