Investors’ emotions often overpower their ability to think and act rationally when they are under stress, whether they’re excited about a market surge or panicking over a decline. It’s called “emotional investing” and, buying or selling, it can wreak havoc on your investment portfolio. Taking a rational and realistic approach to investing during the most stressful of times is essential to preserving the integrity of your portfolio.
Let’s look at five common investor emotions that can ruin a portfolio.
- Greed. It’s natural to want to acquire as much wealth as possible in the shortest amount of time. But a “get-rich-quick” mentality makes it hard to maintain gains. Consider the internet-related tech boom of the late 1990s. Investors jumped to invest in virtually any business with a “dot-com” at the end of its name. Tech stocks became grossly overpriced, creating a bubble that burst in mid-2000, depressing the markets through 2001. Investors lost thousands. The dot.om boom and bust is but one example. More recently cryptocurrencies like Bitcoin and a variety of IPOs have curried favor as get-rich-quick investment schemes.
- Fear. Investors can be just as derailed by fear as greed. When stocks suffer large losses for a sustained period—or in periods of extreme volatility—investors can grow nervous and fearful. But fear can be as costly as greed. This played out in 2008 when stocks took a nearly 40% hit and investment portfolios lost more than a third of their value, but skittish investors took even bigger losses by dropping out of the equity markets in search of “less risky” investments, or even converted their investments to cash. They missed the quick recovery of 2009, and spooked investors who stayed on the sidelines have missed out on one of the longest and strongest market recoveries in history.
- Too Conservative. Fear can also make investors overly cautious and too conservative, curbing their chances of living the good life in their golden years. Because retirement can easily last more than 25 years, retirees must continuously grow their nest egg or face the risk of outliving those savings. Being too conservative not only keeps you from compounding your invested dollars but could leave you unable to keep up with inflation.
- Too Aggressive. The gambling investor is particularly susceptible to the lure of “story stocks,” companies with big ideas but few fundamentals to back up investors’ hopes. They make impulsive buys based on hearsay or media reports that can be outdated, short-lived, or even based on rumors. These investors tend to display too great a confidence in the markets. They are risk takers with illusions—or delusions—of grandeur that can steal them from their investment goals and devastate their retirement hopes.
- Pride. These investors are “do-it-myselfers.” They sometimes think of themselves as the “smartest guys in the room.” While they believe they are picking investments based on their rational analysis, they are typically responding emotionally to changes in market prices. They sell winning investments too soon and hold losing investments too long. Their overconfidence often leads them to underestimate their overall investment risks, which can lead to an unhappy ending. They tend to try to time the market, which is futile.
Avoiding emotional investing is sometimes easier said than done. But there are things you can do to avoid chasing unrealistic gains or overselling in panic. Understanding the risks associated with investing—and your own risk tolerance—can help you make more rational decisions.
Diversification and working with a trusted advisor can take the guesswork out of investment decisions and reduce the risk of poor timing. The data shows that following a well-defined investment strategy and staying the course through market volatility results in the best long-term performance returns.
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.
The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.
HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.