Investing with emotions can be very costly

We all invest with the idea to make a profit and limit the losses. And it sounds very reasonable and rational but investing for most people is all but rational.

Why? Why is it so difficult to remove our emotions from investing decisions? Well… the answer is very simple, we are humans, we don’t like losing, especially when it is our hard- earned money.

Believe me, if you were to be making decisions about someone else’s money, there would be no emotions, you would be able to make a very rational, well thought through decision about what is the best course of action in the particular situation.

But because it is your money, your hard work, your nest-egg, most people are unable to separate thinking from feeling, and the feeling will always win.

Even if that leads to a very detrimental decision, that can negatively impact your life for a very long time.

What’s worse, we are able to always justify our decisions, even or maybe I should say especially the wrong ones. It makes us feel better, but it does not improve your bank account, if you already lost money due to wrong judgement and wrong decision or wrong timing.

And today we are talking about the subject I am quite passionate about:

Investing with emotions can be very costly

Just recently I did a video: “Investing into shares – how risky is it?” that partially touches our today’s topic, although I was talking purely about investing into shares as a separate asset class.

In general we all love investing when things go well. As a matter of fact, we often think:

• • why didn’t I invest more?
  • why was I hesitating with my investing decision?
  • some are maybe even regretting not to borrow money to invest

Why are we thinking that way?

It is our fear of missing out, we want more of the good thing and of those positive returns.

But if we just turn the table and market starts going downwards, meaning we start losing money, now we want to limit our losses and we start irrational behaviour of selling investments in the most depressed market which only creates the financial loss, regret and resentment to investing.

This is exactly what our emotional behaviour looks like in the rising and falling market – let’s just analyse this drawing:

We have funds ready to be invested, but we wait until we get confirmation from the market that it is safe to invest, therefore we go through those emotions of feeling encouraged, confident, then thrilled and then the action time, we buy our investment with the full euphoria that the market has been so positive. But we’ve waited too long, the market already had it’s run and now, just after we invested our hard-earned money, we feel surprised what’s just happened, why the market has just changed, then we become nervous and worried, until it comes to a panic mode, when we cannot accept those losses any longer and we ..sell. But it is all too late, now our sale just means we accepted all the losses.

If one goes through such an emotional rollercoaster every so often, no wonder at some point you had enough. 

So let’s see what is the difference between a professional, unemotional investor and a person that acts emotionally and follows the herd of buying when others are buying and selling when others are selling. 

When looking at 3-year return between 1993-2021, the “following the herd” investor has returned approx. 5.5%pa, while going “against the herd” would provide the return of 15.0%

But let’s be honest, most of us would not be able to get the market timing right, but if you only control your emotions, stop acting like everyone else, take a deep breather and just for not doing anything, your average annual return of just the S&P 500 index would have been 10.7%.

OK, this is not an Australian index, but rather top 500 companies in US, but the message remains the same. Stop acting emotionally.

The trick is to understand the motivation behind emotional investing and avoid both euphoric and panic behaviour and traps that can lead to very poor investment decisions and ultimately negative investment outcomes.

And if you cannot do it, or if you would like to do better than an average, than make sure you work with an advisor who can assist you in building a well-diversified investment portfolio and will spend time with you to change your way of seeing the market, and rather then seeing something as a negative and a loss, view it as an opportunity and growth.

And this is exactly what I see is happening today:

• We had pandemic – fortunately the worst appears to be behind us
• there is a huge problem with inflation – and each part of the world is dealing with it differently, but it appears that inflation should start to decelerate over the coming year
• and of course, the war in Ukraine – where the outcome appears uncertain

But just look at the graph and the history of market and all the crashes along the way.

We always see the one that impacts us as the worse, but if the history is of any indication, all passes, and the market will start rising again ever greater than before. 

As Winston Churchill said: 

“The pessimist sees difficulty in every opportunity. 
The optimist sees the opportunity in every difficulty”

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement