Emotions define how we behave as well as the attachments and significance we hold towards an entity. Underlying the decisions we make, including those pertaining to investments are the murmurs of our emotions. This knitting of emotions and decision-making is not easily undone but can only be assuaged with a rational and calculated approach to decision making. It is hardly surprising then that Economists study behaviour and emotional patterns to ascertain how they constrain or spur on investment and financial decisions.
Having established the linkages between emotions and decision making, let us explore how emotions affect how we spend and invest our money. Have you ever made a purchase on impulse – a whim only to sit back a couple of days later wondering why this purchase was
made in the first place? How often does this happen? You find that our lives are littered with such instances. Fear, regret, anxiety, insecurities, and an aversion to loss are typical emotions that come to play when making financial and investment decisions. An investor with a fear and aversion to loss may prefer investing in bonds rather than stocks due to their perception of embedded risks. Whiles this aversion may be warranted, with a more rational approach and risk-return considerations the investor may be best served allocating to stocks or investing in a combination of both. Fair to say that emotions may preclude a thorough, wholesome and fact-based approach to investing.
Certain tendencies compound the effect of our emotions on investment and financial decisioning. Regret and bandwagonism (bandwagon effect) is a case in point. An investor in a bid to avoid the feelings of regret may take the view of the masses in relation to the suitability of a particular investment. In other words, one simply invests in a venture because the masses deem it to be profitable. There is no rational, structural or economic basis underpinning that investment choice. A real-life example of this occurred during the Gamestop Mania in early 2021. This saw the value of Gamestock, a previously downtrodden stock increase to levels never seen before. A number of retail investors in a bid to avoid the regret of missing out on such astronomical returns simply jumped on the Gamestock bandwagon without considering the inherent risks and the potential for loses down the line.
Similarly, excessive optimism may cause investors to throw caution to the wind and with reckless abandonment, pursue investment they are optimistic about without evaluating the appropriateness of the investment. They ignore the fundamentals and ride their luck.
What are some of the approaches we can consider to ensure our money is well invested? How do we make sound investment and financial decisions devoid of emotions? My first recommendation would be to take a goals-based approach to investing. This places a person’s most important aspirations and goals at the forefront of investment decisioning. This allows the investments to be evaluated in terms of the probability of successful attainment of these goals. It also reduces the propensity to make emotion fueled investment and financial decisions.
Another obvious recommendation would be to hire a financial planner or an investment manager to oversee your finances and investment needs. Financial planners provide recommendations and investment choices based on your financial situation, return objectives and risk tolerances.
Lastly, I recommend taking a consistent, rational and fact-based approach to investing. Do not simply invest in ventures because they appear profitable. Ensure that there is a reasonable basis for thinking that profits are likely to continue for the foreseeable future.
Written By: Nii Amon Neequaye
Senior Quantitative Investment
Suncorp Group (Sydney,
New South Wales, Australia)