Emotions Versus Investing
February 16, 2017
“Human Behavior Flows from Three Main Sources: Desire, Emotion, and Knowledge.”
Articles are written daily with similar titles to those listed below and they often saturate our web browser’s advertisements. Like much of the news we consume, sensationalism is prevalent and stories and claims are delivered with the goal of eliciting an emotional response.
Be it newspaper, cable news or public radio, an active investor consuming media each day is like Superman basking in the glow of kryptonite. This has never been truer than it is in the contemporary U.S. where news information has the potential to saturate every moment of our existence. Whether it’s glancing at our phone or tablet and reading about a natural disaster, reading the news on your computer at work in the morning and learning of a change in leadership at an important company in your portfolio, listening to a story on the radio about the market as we commute home from work, or simply watching the evening news once you get home, the media appeals specifically to our emotions and in turn, our decisions.
Most decisions we make are the combination of an emotional as well as a rational response. In some situations, our emotions dominate our decisions and in others our rational thoughts prevail. Philosophers, like Socrates and Plato, warned against the human inclination for untethered emotional responses and conversely championed those who could successfully redirect purely emotional responses through a decision-making process dominated by the purifying filter of reason.
When it comes to attaining wealth through investing, emotional and behavioral decisions are often at odds with the prudent, sound and rational decisions required for ultimate success.
The renowned analyst Benjamin Graham wrote in his book The Intelligent Investor, “The investor’s chief problem – and even his worst enemy – is likely to be himself.” When Graham charges us as our own worst enemy it is not because he assumes we have the wrong information, that we do not know enough about investing or finance or are incapable managers of our own portfolio, rather, he is speaking far more fundamentally about the role that psychology and emotion play in human decision-making. We are our own worst enemy because so often our emotions, or that elusive “gut instinct” people so often reference, can actually lead our investing astray.
Whether it be a rash emotional decision to sell because of a bad news report and the fear of a plunging market or stubbornly holding onto an overly concentrated stock position due to an emotional attachment (“I worked for the company for 30 years!”), emotions often adversely affect an individual’s ability to make prudent or rational decisions. Both anecdotal evidence and more concrete data support the truth that the most successful investors are those who check their emotions, biases, and even their personal perspective on the markets at the door.
This is certainly not as simple as it sounds. We are built to rely on our emotions and social intelligence to navigate many of our important decisions in life. What school to attend, what to study, what job to take, who to marry or partner with on a business venture, require us to use our “instincts”, those organic inclinations that come to us naturally, without much effort and yet at the same time many of these decisions include research and assessment of key indicators during our own personal due diligence process. Many experienced investors will admit to one or more experiences in their early investing days when they let their emotions get the best of them and as a result suffered a major loss. It is difficult for even the most intelligent and savvy investor to avoid getting jumpy or being overly stubborn because of their “gut instinct.” Some investors may get jumpy, react and then rationalize that the decision they have made was in fact a good one. This is known as the illusory superiority effect. People (investors) act on gut instinct and then rationalize that they are doing a great job.
So, how do successful investors manage to keep their emotions in check? And what do they rely on in their decision-making process in lieu of their “gut”?
The Wisdom to Consume Media Wisely (and to Mostly Ignore It!)
What is the primary source of information for the average investor? What creates the most emotional reactions in the market? Almost always, it is the media.
The news is designed with one thing in mind: keeping people hooked and tuned-in. A wise investor knows that what is being reported in the media is intended to speak to our gut. They also know that the story changes, sometimes drastically, from one day to another, even one moment to the next. It is easy to hear of a specific instance, situation or potential occurrence and misguidedly seek action in an attempt to avoid a hypothetical fall-out.
The same could be said about actions taken in order to take advantage of a specific situation. When it comes to your own portfolio, media and the news should be thought of as a limited tool, only very loosely related to long-term performance. We can use our gut reactions to the media as prompts to seek out real information: research and data that spans more than just one news cycle and gives us real insight into the potential long-term outcomes of a given environment.
Market sentiment is very useful to track, and is one of the four pillars of research that Polaris Greystone uses to manage our clients’ portfolios. This contrarian indicator can be a powerful tool when used in conjunction with fundamental research, macro-economic research, and technical research.
Get Out of Your Own Way and Delegate Responsibility
Replace “gut instinct” with clinical investment decisions. For some investors this doesn’t mean that they start a huge research project every time they have a decision to make. It means they seek the counsel of a trusted, experienced and unbiased wealth advisor, whose job is to build up not only knowledge but wisdom with regards to portfolio management and financial planning. Sometimes even the most financially savvy investors are self-aware enough to know that their own emotions, hang-ups or lapses in attention could easily get the best of them and their wealth so sometimes they find someone to help oversee their investments and financial plan and collaborate with them on major financial decisions as a buffer against getting emotional or inadvertently making a big mistake. Your advisor should be able to help you envision and then execute a thoughtful investment strategy, built to be tactical in order to weather the inevitable storms and squalls that so frequently cloud the financial landscape. And if you get anxious, frustrated, or feel that “instinct” kicking in, your advisor is there to reaffirm your strategy is what may best protect your wealth and keep your plan on course.
Smart investors know that they don’t have the ability to make the right call 100% of the time. Our Managing Partner and Chief Investment Officer here at Polaris Greystone, Jeff Powell, will be the first to admit this in saying things like, “We don’t need to be right every time, we just need to be right more often than we’re wrong!” And although I don’t think he’ll go so far as Socrates in claiming that his wisdom consists merely in “knowing that he knows nothing,” the Socratic approach is evident here in knowing what matters, what we can control, and maintaining our attention on where they coincide. We let these influence our prudent investment and planning decisions.
Know thyself and delegate responsibly.
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