Arnold and Zelda consider themselves to be good investors. Arnold has all of his wealth in bank GICs, a choice he knows and feels comfortable with. He bemoans the low returns – under 2% – that he is currently receiving, but he’s heard too many horror stories of stock market investing. As a result, Arnold may not be able to meet his long-term goals.
Zelda, on the other hand, had been persuaded to invest in bank mutual funds that were giving her fantastic returns in a charging bull market. Then came a market collapse – Black Wednesday. Seeing a 35% drop in her investments, a frightened Zelda promptly sold all her funds before she experienced greater losses, and deposited the money into a savings account where it still sits.
Arnold and Zelda are using emotions – fear and overconfidence – to make their financial decisions.
The behaviour of investors is well documented. People hope for a gain while simultaneously wanting to protect against losses. It’s easy to be irrational when your hard-earned money is at stake.
Fear of investing
Fear is usually caused by lack of knowledge, which makes people less confident about investing. Fear of investing often results in a significant amount of holdings in cash or low interest products, or selling investments at an inopportune time.
“I don’t know what I’m doing.” More often than not this has to do with a mind-set that says, “Not my thing.” You can hand over all investment decisions to a professional. However, investing with a pro shouldn’t be a one-way street where you just supply the money and he or she puts it somewhere. It’s incredibly easy not to pay attention once all the forms are filled out.
Do you know where your money is invested? Are you influenced by the nice, friendly man who promises huge returns for very little risk? Do you know what you are paying in fees and commissions and how that affects your returns?
It might not be your thing – but it is your money. Any professional should be able to talk to you in layman’s terms about what he or she is doing and why. It all boils down to taking responsibility for your money – discussion and collaboration. You need to feel confident and comfortable talking about your finances.
Optimism
When people listen to stories from friends, family, and co-workers about the killing they are making in the market they think, “Why not me?”
Then they take the plunge into stock market investing. The market has been going up and they assume it will continue to do so. This often results in portfolios that are too risky.
These investors also listen to mass media financial gurus and are encouraged to pursue the latest hot stock at peak prices. They tend to place too much credence in recent market views, opinions and events.
Overconfidence
People generally rate themselves as being above average in their abilities.
Overconfident investors are those who think they can beat the market. They don’t consider getting any help or look into other options because they think they know already. They may be dead wrong about things they think they do know.
Regret
Regret comes after realizing you’ve made an error in judgment. We all hate to be wrong. Faced with selling a stock, investors become emotionally invested in how much they paid for it, which brings about loss-aversion and holding onto their losers. There’s regret of having made a bad investment and facing a loss. There’s regret when a stock you were considering buying – but didn’t – has increased in value.
The real cost of investing
Investors can be their own worst enemies. Our personalities are a driving force in how we invest, so knowing yourself and facing your feelings about investing is of paramount importance.
When it comes to money and investing we are not always as rational as we think we are. We lose more money by making poor choices than by getting a low return.
Investing without emotion is easier said than done, especially in periods of uncertainty.
I have been through four or five market crashes and, rationally, I know it doesn’t matter in the long term. But, my stomach still sinks when my portfolio is down. We don’t like to lose.
However, implementing a well thought out strategy and sticking to it may help the investor avoid many common investing mistakes brought about by emotions.
