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10 Emotions That Can Wreck Your Ultra-High Net Worth Portfolio

Can You Control These Emotions When Making Investment Decisions? Research Says – Not Likely

Classical economics has believed for generations that people will act rationally to achieve whatever is in their own best interests. If it leads to greater satisfaction, people will do it, the theory argued.

What we have learned over and over, and again just recently with the COVID-19 recession, is that this just simply isn’t true. Investors – and people in general – very often do not do what is in their own best interests. They cannot be relied upon to make the best decisions for themselves.

One primary reason for this is emotion. We are emotional beings, and emotions tend to make terrible investment decisions. Recently, several research studies have started to explore why and how this is true.

Leaning heavily on a terrific summary of some of this research from The Globe and Mail, we’ll be exploring ten emotions that work against success in your investment decisions. You’ll want to acknowledge and identify these ten emotions in yourself, and work out a system to prevent them from undermining your investment performance.

 

One study referenced in the article found that investors lose 1.4-4.3% every year because they don’t do what they should have done. They let one or more of these ten emotions interfere with sound investment decision-making.

 

Suppose you earned 9% in 2019 but were driven by too many emotions in your investment decisions. This means you could have earned anywhere from 10.4% to 13.3%. How much money are your emotions costing you?

 

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1.Confirmation Bias

When we already believe something, it’s easier to ‘prove’ and feel good about our certainty.

When it comes to investing, you might have a preference for certain industries or companies, or even for specific banks or brokerage firms to manage your portfolio. You might think the biggest firms must be the best.

With problematic beliefs like these dominating your mind, you will naturally adhere to information that confirms those beliefs, even in the face of overwhelming contradictory facts from other sources.

For instance, most people are drawn to narratives that are easy to grasp and repeat to their friends. Many know the story of Thomas Edison and the light bulb. Its elegance lies in its simplicity. Fewer know the stories about his heated competitions with Tesla and Westinghouse, which complicates his legacy and story quite a bit.

Likewise, we make decisions about companies because we already believe in them. We write off industries we don’t believe in, even if all the data points to them as rising forces.All it takes is one story or one anecdote that supports our position, and we throw out all the other evidence that stands against us.

 

This is why so many investors buy high and sell low. It’s why they stick with an investment firm or a mutual fund that charges outrageous fees. It’s why they hold on to battered stocks that have almost no chance of rebounding.

 

2.Fear of Loss (Loss Aversion)

As The Globe and Mail puts it, the fear of loss “inflates the psychological impact of an investment loss to about double that of an equivalent gain.”

Have you ever felt that?

You gain 10% or 20% over a year or two, and you barely acknowledge it. But when you lose that same 10-20% in a market downturn, you feel panic and anger rising up inside you. Why no joy or happiness when you gained it? Why so much fear when you lose it?

The fear of loss drives us to avoid taking smart risks that would very likely be good for us in the long run.

 

3.Anxiety

Closely related to fear of loss is anxiety. One Stanford study put people in an MRI and monitored their brains while they made simulated trades. They found that the part of the brain most associated with reason and logic seemed to dominate their investment decisions at first.

But when the traders started making overly conservative decisions, the part of the brain associated with pain and anxiety increased in activity.

Anxiety leads to risk-avoidance, which leads to under-performance in many cases.

 

4.Pleasure

The same Stanford study also found that when traders went after big gains, their blood rushed into the part of the brain associated with pleasure and euphoria. It’s the same part of the brain that lights up when we enjoy food, drugs, and sex.

 

Making big money is pleasurable, and when we feel like we’re in hot pursuit of it, that emotion is what drives our investment decisions. This is why it’s not at all inaccurate to compare investing (especially active trading) in the stock market to gambling. The same emotions are in play.

 

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5.Reckless Impulsivity

Another study gave testosterone supplements to traders in a simulated session. The purpose was to study the common stereotype about overly aggressive, risk-taking, young male traders, and see if there was any truth behind it.

As it turns out, those who took the testosterone supplements became much more impulsive and reckless in their trading and investment decisions. It was so harmful that it affected the whole simulated market in the study, artificially inflating the prices of certain assets.

Have we ever seen inflated asset prices in the real stock market?

You might have science on your side if you want to blame it on the boys.

 

6.Familiarity Bias

Market watchers have noted that equities with names and ticker symbols that are easier to pronounce tend to perform better than those that are harder to pronounce.

Of course, this is absurd if reason and sound logic were governing everyone’s investment decisions. So the fact this trend has been observed points to the invasion of emotion into the system.

Another example of this sort of bias is the ‘herd mentality,’ which we have pointed out on this blog many other times.

Investors chase after ‘hot’ equities and 5-star mutual funds, not aware or refusing to acknowledge the objective reality that these assets have already experienced their big increases, and are destined most likely to either level off and plateau, or even lose value.

Very few 5-star funds retain that rating for more than a few years, but the emotional lure and attachment caused by familiarity bias continues to draw people to them. The same emotion leads people to join bandwagon fads like ‘cryptocurrency’ investing, which inflated and popped in less than a year.

Running after the herd almost assures you of under performing investments.

 

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7.Self-Deception

This emotion can take a variety of forms. For instance, inflated self-confidence can arise when we attribute our investment successes to our own talents, but then write off our failures to forces beyond our control like a political party, technology, the media, or some other nebulous ‘villain.’

Self-deception can make us think we are more clever and smarter than other investors, that we have special knowledge, good instincts, and reliable intuition. We think our ‘gut’ usually gives good advice.

This is nothing but emotion running wild, masquerading as intelligence and talent.

 

8.Recency Bias

Investors also tend to make decisions that place too much emphasis on recent events. This is why the stock market often rises and falls based on political decisions and elections.

The rational person knows that almost nothing that happens in the political world has any effect on companies, assets, market value, and growth for at least several months. But more often, it’syears. How is it that Congress can be labeled as do-nothings, but at the same time whenever the majority shifts or a new president gets elected, markets react immediately – sometimes before they even take office?

If they do nothing, then how great can their impact on the markets be?

Similar emotions arise when a company launches an IPO. They just launched, so it must be a great buy! Yet, sometimes just a day or two later, the value has cratered to half what it was on the day of the launch.

The bias toward recent events causes massive fluctuation in markets, and investors are prone to the same baseless emotions as they make decisions about their portfolios.

 

9.Insecurity

When markets crash with little warning, such as in the coronavirus recession, the feeling of insecurity rises quickly, leading to panicked decisions to sell, or overly cautious decisions not to invest in something that would be a smart move.

This is why you see the market gyrating so much sometimes in crisis. It went down 30% in one day, and then back up 11% the very next day in February, in the early days of the pandemic.

Rationally speaking, this kind of movement should pretty much never happen. Nothing happened to any companies to justify anything close to that degree of change in just two days. In fact, the real damage to the economy didn’t start arriving until a month later, when layoffs and job losses started to pile up.

The market thrives on insecurity. It’s your job as an investor to not be sucked into it.

 

10.Unfounded Optimism

“Everything is going to work out.” “You can’t lose.” “If you just think positive, you’ll be fine.” “Follow your heart and everything will turn out great.”

Silly declarations like these that have no basis in reality nevertheless lead some investors to make terrible decisions with their portfolios.

Even the most experienced and smartest investors with the best track records make mistakes. One reason they became so experienced and smart is because they never lost sight of their own capacity for failure and their susceptibility to emotional investment decisions. They worked tirelessly to suppress their urges.

 

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Study Finds Emotions Lead to Bad Investment Decisions

 

Yet another study, from 2005 and referenced in the same article, studied the investment behaviors of people who had brain damage in the areas of the brain related to emotions. They weren’t able to feel things like fear or anxiety or unfounded optimism. But they were able to make intelligent decisions.

This group was pitted against a group of people with undamaged brains in a simulated investment game.

Every single participant with a damaged brain outperformed those with undamaged brains, and ended the game with more money. Those with regular brains became more conservative as the game went on, as their anxiety and fear overcame them, no doubt instigated from early losses brought about by other emotions on this list.

 

How Do You Prevent Emotions from Interfering with Your Investment Decisions?

 

The truth here is tough to take, but you need to hear it.

It’s almost impossible.

When it’s your money in play, you will feel emotions. When you do well, that pleasure center will try to take over. When you do poorly, the fears and anxieties will drive you to make terrible decisions.

It is exceedingly difficult to consistently fight these emotions off, year in and year out, for the twenty, thirty, forty, or fifty years you will need to manage your portfolio through the rest of your life, as you seek to achieve all your lifestyle and financial goals and dreams.

The only way to escape the influence of emotions in your investment decisions is to remove yourself from the equation by getting a financial advisor or wealth manager.

Pillar Wealth Management approaches all our investment decisions on behalf of our clients from a non-emotional, data-driven, objective perspective. We develop portfolio plans based on historical data and the goals of the investor. We implement them, adjust them, and monitor them – always based on the data and your life situation.

We do not panic when a virus tramples the globe. We don’t second-guess our strategy when a new president gets elected. We don’t get nervous when tax policy changes, or when a huge company goes out of business, or when a recession hits unexpectedly.

We stick to the data.

Our goal as fiduciaries is to do what you are supposed to do but struggle with because of emotions – act in your own best interests. We act in your best interests – continually, and without fail.

Not every financial advisor does that. And not every advisor has a process so refined that it removes the influence of their own emotions. Some advisors do panic. But not us.

If you want to hear more about our emotion-free portfolio planning process, click the link below and schedule a quick call.

 

See Our Emotion-Resistant Portfolio Planning Process – Unlike Anything You’ve Seen

Schedule a Free Chat with CEO and Co-Founder Hutch Ashoo