Curb your emotions
NEW YORK – One thing that separates humans from robots is our capacity to feel – and our ability to throw away absurd sums of money on dud investments.
We mean well – most of us think we’re making smart decisions when we invest in a stock, mutual fund, or even a house, but our reasoning is often clouded by personal or emotional experiences that can delude us into believing the most preposterous of notions. Worse yet, we aren’t even aware of the influence emotions have on our decisions.
“I think the best investment strategy is to pick some stocks or mutual funds you like, and stick your head in the sand and protect yourself from emotions that are going to cause you to do stupid things,” said George Loewenstein, a professor at Carnegie Mellon University.
Loewenstein collaborated on a study last year that found that people who had suffered brain damage made better financial decisions than those who hadn’t. The study compared normal people to those with neurological diseases that impaired emotional responses. Participants in the study were given $20 to invest, and in each round they could either invest $1 or they could refrain from investing, in which case they got to pocket the dollar.
After roughly 20 investment rounds, the study found that emotionally impaired participants invested more often – they invested in an average of 83.7 percent of the rounds, while emotionally normal participants only invested in 57.6 percent of the rounds. The emotionally impaired group earned more, too: They made an average of $25.70, while normal participants earned $22.80.
“People with emotional lesions invested at a very high rate, while normal people, if they lost money, they got discouraged. If they won a few times, they got nervous that their luck wasn’t going to hold out,” Loewenstein says.
How do we let emotions get in the way of our investments in real life? It happens all the time, according to Gregg Fisher, president and founder of investment advisory firm Gerstein Fisher. Off the bat, Fisher says, we tend to hold on to high-return, winning investments longer than we should, and we’re reluctant to sell losers until we’ve won our money back, even if that’s an unlikely outcome.
“People tend to hold on to things even if they’re no longer favorable investments. … People put more value on things they already have,” Fisher said.
Likewise, Fisher says, people often have wildly optimistic ideas about what kind of returns they’ll get on investments.
“Maybe someone buys shares of Google at $100, and the stock goes to $400, so he has a good experience with it and he wants to buy more – but buying shares at $400 may not be the best way to invest. People have a positive experience, and they take it and extrapolate into the future – it’s a mistake,” Fisher says.
Another common error, according to Fisher, is our fixation with the familiar. We’re less likely to invest in a company or mutual fund if we don’t have a direct or positive feeling about it.