Emotions & Investing Don’t Mix
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Have you noticed the herd mentality in the stock market?
How people react when one country has financial trouble?
How when one company’s stock in a sector does poorly, others seem to follow suit?
How some people freak out at the slightest drop in the value of any investment?
People sell their stakes in investments for a number of reasons.
Some do it because they have a fear of losing money.
Others do it because they want to harvest tax losses.
Some people panic and take every piece of news, hearsay, or “financial advice” at face value rather than taking the time to dig a little deeper in order to find their own guidance.
The thing that many people do not do is follow the same reasoning when selling stocks as they did when they made the initial purchase.
Too many people let their feelings and emotions affect their investment decisions, which is one place where rational, level-headed decision-making is vital.
First I have one simple question to ask.
Why do you own the stocks/bonds/ETFs/mutual funds you do?
Take some time to think about the answer for a minute or two.
It’s not the simplest question to answer, is it?
Maybe it’s difficult because you don’t even know why your portfolio contains what it does.
That is, at least in my humble opinion, the biggest problem among those who invest in stocks.
A great majority hear something on CNBC, Bloomberg, or some other media outlet, or from a family member or colleague and invest in that company simply based on a recommendation.
In a time when people are choosing to be more frugal and efficient with their money, why would anyone want to throw money around in a brokerage account and more specifically in a retirement vehicle?
There is a school of thought among some advisors that investors should keep a journal and jot down a few notes about their feelings and thoughts involved in every trade, whether buying or selling.
This is something that I absolutely agree with and recommend to people with who I come in contact.
The point of this exercise is to actually think about each trade and record the reasons behind each transaction.
This way, when it comes time for your periodic review of your portfolio, you will have a better understanding of your allocation and why you possess each security.
In addition, it will give you some insight into your investor profile as well as your level of risk tolerance which can be of great assistance especially if you decide to bring in an advisor at any point in the future.
Keeping a journal and actually spelling out your rationale for every trade will help you in another vital manner.
Heck, this doesn’t even have to be strictly for traditional investing.
This can even apply when investing in collectibles since you always have a “why”.
In times of rough periods such as this, when certain companies see no significant change in their business strategy or performance, yet still suffer a loss in share price, you will be reminded of exactly why you purchased or sold it off it in the first place.
You will be reminded that if you bought the stock for its strong balance sheet or the high dividend yield, or strong cash positioning, a sell-off or a little bad news won’t affect you as much.
On the other hand, if you sold a particular stock for any particular reason, and the situation is still the same, you will have the written reminder to avoid that company regardless of how attractive a value it may be until the circumstances change to one that you are more comfortable with.
By keeping track of the reasons behind your investment decisions, you will be in a better position to withstand unexpected changes in market attitude.
You will also be able to dismiss most of the information and rumors that are tossed around if it has no impact on any of the reasons for either acquiring or disposing of any particular stock.
This approach to investing also has a more subtle result: it will help you curb your emotions when choosing to invest by making you take a more analytical and thoughtful approach and assist you in becoming a more wise investor.
I agree emotions can raise havoc with finances. However, when it comes to investing you need to make sure you know what your moral code is and where you stand. This is different than being emotional. To me it means I invest in things that I believe in and support. Being a green thumber, investing in oil companies isn’t for me. That is not an emotional decision though.
Oh yeah, there is clearly a difference between emotions and morals, and that oil company example is a great one!
I don’t keep a journal but it’s not a bad idea. If I ever consider selling a stock, I have to remind myself that losses aren’t real until you sell. That typically keeps me from acting irrationally.
Anything that help, I am all for doing. I only wish I could remember where I first read about the journal. Sucks getting old and remembering some things…
I think there a lot of great reasons to record emotions prior to trading, especially selling. I don’t, mainly because I haven’t sold any financial assets for years. Next time, I will pause to reflect on my emotional impulses. Great post Eric.
I actually have to thank you Hunter. This post came about from commenting on your blog!
It’s important to keep emotions out of investing, but perhaps it’s easier said than done. Even when it comes to making a purchase, I look at the price before I even decide if I like something or not. It’s too expensive to get emotionally attached to something and pay a premium for it.
If you record your feeling and thoughts going into any transaction, it helps you to understand your tendencies. Of course, it may not be for everyone. you just need to find what works fr you and stick with it.