When there is money involved, emotions can run high. Yet letting your investments be led by those emotions will likely have a negative impact on your returns. Matt Allgeyer, Financial Planner with Wamhoff Financial Planning & Accounting, discusses emotional investing, and how to not fall into its trap.
1. Causes of emotional investing
- Market volatility: the ups and downs create a very emotional response from investors.
- Chasing returns: investors get excited about gains of the past, and move money into those investments after it has already had its gain.
- Bad planning: the absence of a good financial plan creates lack of guidance, so the investor follows the emotion rather than following a plan
- Lack of time and knowledge: most people don’t take the time to perform research on individual stocks or investments, so they rely on intuition rather than facts and data
2. Why emotional investing doesn’t work
- Timing is usually off. When following emotions, investors tend to buy high and then sell after experiencing a loss.
- Emotion can cause the investor to have knee-jerk reactions.
- Because there typically isn’t a solid plan in place, there isn’t a clear goal or strategy for how to get there, so the investor can’t make decisions designed to get him/her from point A to pointB.
- History tells us that those who don’t panic in down markets achieve better results than those who let their emotions lead their decision making. In fact, in the last three bear markets (a 20% or more market loss) is followed by an average market gain of 32% in the following year.
3. How to avoid emotional investing
- Replace worry and emotion with planning.
- Think about why you want to make the move you’re considering. Are you moving out of fear, or are you making an educated move?
- Find an advisor to help. An advisor has a vested interest in your plan with knowledge of market history, and can invest without following the emotional roller coaster