Are You An Emotional Investor?
Just as important as your financial capacity to take risks when investing is your emotional capacity to take risks. Why is this important?
This is important because although an investor may be able to afford to undertake an investment financially, they may not have the emotional maturity to handle such an investment. Many investors fail to recognize the role emotions play in their investment decisions. If they allow themselves to be ruled by emotions such as fear, greed, peer pressure, or regret, they may not possess the emotional capacity to invest and make poor decisions down the road.
How can emotions cloud sound investment judgment?
Take, for example, greed or peer pressure. If you see other investors, friends, or family members piling into an investment, greed may take over because you want to be part of the gold rush. Peer pressure or the fear of missing out (FOMO) might also play a role because nobody wants to be on the outside looking in.
These emotions may ultimately cloud sound investment choices as investors ignore basic financial fundamentals. Greed and FOMO are constantly displayed, and examples of mass hysteria throughout history are abundant. Remember the dot-com bubble of the early ’00s? The housing bubble in 2008? What about meme stocks as recent as last year?
While greed and FOMO propel investors to rush in when they shouldn’t, other emotions may prompt investors to get out of investments too early or to stay in too long. Some investors may fall victim to fear and anxiety, which may cause them to liquidate or abandon an asset at the slightest sign of trouble. It may undermine logical thinking and common sense.
On the other end of the spectrum, while fear and anxiety may cause some investors to jump ship too soon, these emotions may cause other investors to stay in too long. As losses deepen, some investors become more and more emotionally paralyzed – to the point of inaction.
Fear may also keep investors sidelined when some of the best opportunities arise. The key during downtimes, as with any time, is to put emotions aside to judge an investment on its merits and not because of any emotional factors.
To succeed in investing, you have to learn to corral your emotions.
Like a fighter pilot, you’ve got to be ice cold and set your emotions to the side to assess a situation or investment based on data, facts, numbers, and metrics.
Emotional Neutrality – removing greed, fear, and other human emotions from investment decisions – is the key to investment success. You should only invest if the data and numbers make sense. You shouldn’t invest in something because everyone else is doing it or buzzing about something on social media or online forums.
It’s easy to go along with the crowd, but history has proven that going along with the crowd often leads to disaster. See my examples above, starting with the dot-com bubble. Crowd behavior is a close cousin to emotional contagion – when investors pile into an asset or industry because of the rush of excitement from a so-called “can’t miss” opportunity.
Please don’t base your investment decisions on emotional contagion because it often leads to irrational behavior that prevents sound decision-making. Besides, the savviest and most successful investors are the ones that go against emotional contagion. When everyone rushes into an investment, smart investors usually stay back. And during volatile times, while everyone liquidates and sidelines their capital, savvy investors look for opportunities. They realize that some of the best opportunities arise when nobody else is looking.
Despite the current inflationary and uncertain economic environment, do you have the emotional maturity to seek sound investment opportunities? Or will you succumb to the emotional contagion spreading through the masses that says you should be fearful and cautious?
What can you do to put emotion aside?
One solution is to mentally train yourself to put emotion aside through patience, discipline, and self-control. The other is to do what savvy investors do – take emotion out of the investment equation. Like a smoker trying to quit where it’s better to avoid temptation than to fight it, savvy investors prefer assets that make emotions non-factors. How?
By investing in private alternative assets like real estate and private company investments (i.e., private equity), smart investors avoid the fanfare and buzz that plague public equities. The public and the crowds don’t know about these private investments, which altogether erases emotional contagion from the investment decision-making process.
In addition, private investments are illiquid with long lockup periods, which prevent investors from acting on their urges even if they wanted to.
By investing in assets away from the limelight of the crowds, savvy investors can eliminate emotions from their investment decisions and judge opportunities based on the merits. Now, as the markets experience extreme turbulence, do you have the emotional maturity to consider opportunities based on their merits as they arise and not hide from them because of fear and anxiety?
History has proven that there are good investment opportunities in every environment.
Taking advantage of opportunities in this environment and profiting from them will push emotions to the side and judge them based on the data, metrics, numbers, and math. What will you do?