When we scrutinize our stock holdings, many of us might find a few losing counters that have been there for a long time. One of the many reasons why we still hold on to these counters is simply because we are hoping that one day its price will go up and we can then sell them off. In theory, we know that there should be a limit to trigger us to sell off these counters when our investment value falls below our minimum limit. However, in reality, we procrastinate for as long as possible as at the back of our head, our mind is telling us to wait. At the end of this article, you will be able to identify how emotions affect our investment decisions.
Traditional investment theory is based on the assumptions that investors will be rational in arriving at their investment decisions. Unfortunately, whilst we understand the need to be prudent in our investment, act reasonably and make our investment decisions based on all available information and objective analysis, most investors are always influenced by their emotional state when they decide to buy or sell their investment holdings.
Positive emotion versus Negative emotion
It is human nature that we react differently when we are in a different state of emotion. In the book ‘Inside the Investor’s Brain’, written by Richard L. Peterson, research has shown that when people are happy and satisfied with their life, they tend to be more confident with the decisions that they make. Their decision making process becomes simpler. They will be less involved in the minute details in information gathering, able to ignore irrelevant information, be willing to consider fewer dimensions and use less time to decide on what they want to invest. Optimistic people tend to take on more risk when faced with moderate stake. However, given a high risk and high gain situation, they will forego the potential to gain in order to avoid the risk of losing their current state of happiness.
On the contrary, when people are in negative state of mind, they become very suspicious and indecisive. They will try to use whatever information that they can get hold of to analyze their investment decisions in order to avoid taking even the smallest risk, and end up over analyzing information which will lead to them making the wrong decisions. They are paranoid over every small loss that they make and take a long time to get over any failures. It is the fear of regretting any wrong decisions that make them hold on to their losing stocks. However, given an opportunity of high return, they are willing to take the high risk with much hope of pulling themselves out of their current state of despair.
When investors are emotional, they are also prone to think that their current state will continue into the future. For example, if an investor is currently earning huge profit from his high risk investments, it will be unlikely for him to diversify into less risky investments as he will be feeling confident in his investment acumen. On the contrary, an investor who gets burned badly in the market downturn will hesitate to invest even though there are signs of recovery as he will be thinking that these signs are just temporary phenomena to entice gullible investors.
When investors are emotional, they are also prone to think that their current state will continue into the future. For example, if an investor is currently earning huge profit from his high risk investments, it will be unlikely for him to diversify into less risky investments as he will be feeling confident in his investment acumen. On the contrary, an investor who gets burned badly in the market downturn will hesitate to invest even though there are signs of recovery as he will be thinking that these signs are just temporary phenomena to entice gullible investors.
As humans, we are bound to be influenced by our emotions. Therefore, we have to learn to detect the emotions that are affecting us those which could cloud our investment decisions. We may not be able to isolate our investment decisions from our emotion, but by knowing what is bothering us, we can take logical steps in minimizing the impact it makes to our decision making process..
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