Investment and financial decisions should not be based on emotions, because that often leads to bad investments and financial losses. Explained here in brief is how emotional thinking affects all major investment types.
Investment decision based on emotions often result in financial losses. In fact, feelings like euphoria/greed and fear are very powerful motivators which trigger “reward circuitry” in the times of financial gains, and “fight-or-flight” in the times of financial losses. Allowing your investment decisions to be driven by emotions may be the single most detrimental action you could possibly take in regard to securing your financial future.
But in order to avoid taking emotional investment decisions you need to understand the problem first. Given below are various investment options and how an emotionally thinking investor reacts to each of them.
Equity Investments
Equity investments fall under asset class and give the best return in the long run. However, one may experience fatal fluctuations in the short run, which would lead to emotional imbalance. As a result of this bad performing stocks are kept in the portfolio in hopes of recovering at some point of time in future, whereas the good performing stocks are often sold out to incur immediate profits. Rational decision would be to sell off bad performing stocks to minimize losses and hold on to good stocks to compensate for the losses on poor stocks. Another equity related emotional decision making is to buy stocks when the market is at it’s peak (“because, you know, everyone else is buying!”), and sell when the market is down (“stock market isn’t for me! Let me sell before it goes down further”).
Savings Account
Many investors keep a substantial amount of money in their savings account which makes them feel secure. But at times of high inflation, this large amount depletes its value over a period of time, because the meager interest isn’t enough to overcome the high inflation. Money in your savings account may make you feel good, but if you invest it somewhere else, it will fetch you more money.
Real Estate Investment
This asset class comes with a huge emotional baggage. Even if, the real estate doesn’t yield good returns, investors are prone to hold on it anticipating the price to go up within a course of time. However, this financial behavior turns into a huge opportunity loss over time. Instead of holding on to these types of assets, investors should focus to deploy their money in other investment options which yield better returns going forward. Real estate investment is not always the best investment option, more so, if you are taking a bank loan to finance it.
Life Insurance
Life insurance is a risk mitigation tool and not an investment since it doesn’t generate effective returns and falls under the category of non-performing assets. Therefore, investments should be made in better performing assets which would eventually recover the costs incurred in surrendering the policy to generate better returns within a due course of time period. You should buy life insurance, but to secure the future of your family and loved ones, not as an investment option.
Gold
Gold is a very popular and common asset class of every Indian household portfolio. But emotional attachment with gold is so high that it is considered to be the last asset to be liquidated in case of emergencies and in most cases is never sold. Therefore, hoarding gold, may give you an emotional high, but if you don’t sell it at the right time, it’s just a piece of metal, not an investment.
In conclusion, if you are able to divorce your feelings from your relationship with your money then you would invariably receive better returns in the long-run irrespective of varying market conditions. Making reactionary decisions, following the herd mentality and being influenced by others will lead exclusively to poor decision making. One way to avoid this is to hire the services of a financial consultant or a consultancy firm.
