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How emotional investing can affect investment outcomes

Date: Feb 24th, 2016

What is emotional investing and how can it affect investment outcomes? In this interview, Jeff Rogers delves into the world of emotional investing and provides guidance to help investors avoid some common mistakes.

How would you describe an emotional investor?

Emotional investors are those who make decisions impulsively, buying in response to hype or selling out of fear. Emotional investing contrasts to an ‘objective’ or ‘disciplined’ approach, where an investor blocks out how they are feeling – as much as possible –to focus on the facts pertaining to an investment opportunity.

How common is emotional investing in Australia and more broadly?

Australians have historically been less exposed to emotional investing than some overseas counterparts. Perhaps this is because much of the savings in Australia are implemented in the superannuation system, which has been built with a long-term focus in mind. In other parts of the world, including the US, investors buy and sell quite frequently and there is considerable evidence that emotions dominate decisions to the detriment of long-term outcomes. However, we do need to be alert in Australia that a combination of easier online access to trading in currencies and shares together with the rise of SMSFs might create a risk in the future.

What common habits would you attach to an emotional investor?

Emotional investors are driven to make investment decisions by stories that create excitement and hype. They tend to be overconfident with regard to the special opportunity they have been presented with. They have a fear of missing out and as markets go up, these investors move from optimism to euphoria, looking to buy more. Then, when markets go against these investors their anxiety grows. They eventually become despondent, embarrassed about being invested at all, and are prepared to sell at almost any price.

Emotional investors tend not to have established the goals for their savings and lack a long-term plan for their investments.

How can it help and/or hinder people’s investment decisions?

Generally speaking, emotional investing hinders investment outcomes because it creates the tendency to buy lower quality assets, to buy at higher than normal valuations or to sell at lower than normal valuations. However, if you are aware that a number of investors are transacting in response to their emotions, it is possible to take advantage of that insight by adopting the opposite stance. A number of successful professional investors incorporate such information into their investment strategies.

Can fluctuating markets impact emotional investing? How?

Volatile markets and strongly trending markets (either up or down) increase the propensity for emotional investing decision making. One reason is that only at such times does investment knock sport and politics off the front page of the paper. When markets are the centre of attention, more people believe they should have an opinion and emotional investors are drawn to act on those opinions.

Did we see more emotional investing during the height of the global financial crisis (GFC)? Why?

It’s not surprising that there were a lot of emotional investment decisions made at the height of the GFC. Despondency is a good characterisation of the emotional state of a number of investors, especially those who had taken advantage of the temporary opportunity to place additional capital into the superannuation system a year earlier. (There is an important caveat here in the case of retirees, some of whom were effectively forced to reduce their exposure because the unexpectedly large decline in markets overwhelmed their capacity to bear the risk. We wouldn’t characterise that action as an emotion reflex).

Should (or could) a sound investment strategy be part rational and part emotional? How?

Humans are emotional beings, so an investment strategy needs to take that into account. It helps if an individual or family can clearly articulate their various investment goals and for an adviser to understand the level of priority around the attainment of each goal. Then strategies can be developed with the best chance of achieving each goal, without substantial risk of provoking a mistimed emotional response on the journey.

Final thoughts

Ongoing, quality financial advice can help investors reduce the risk of poor outcomes due to emotional investing – this is of particular importance in environments of volatile and strongly trending markets, as identified earlier. A key role of a financial planner is to help their clients fight the behavioural urges that are harmful to their long-term financial wellbeing.

About the author
Jeff Rogers joined AMP Capital in 2011 from ipac Securities and he has over 27 years of investment management experience. Jeff holds a Bachelor of Science (Honours) from the University of Melbourne.

Source: AMP Capital

24 Febrauary 2016

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