Knowing your own reactions to volatility and uncertainty (risk) can allow you to become a better investor. Just listening as your advisor explains this is not enough. You have to get intimate enough with risk to recognize your own motives and perceptions and those of others in the market place. Recognizing your emotions is a great place to start. Consider the following:
- When we perceive risk (volatility, uncertainty) the primary emotional response would be FEAR.
- During the depths of our last/current recession the stock market was at the mercy of emotion resulting in a massive sell off in the market. Fear fed upon itself resulting in not only individual investors selling at the bottom of the market but also seasoned advisors. It took someone very intimate with their own emotions to weather the downpour of daily market negativity. (By the way, every seller has to have a buyer, so these disciplined buyers did very well.)
- The housing bubble was in part driven by easy and imprudent lending. However, consumer perceptions of housing values, real estate as an ever rising investment, and a fear of missing the chance to own the “American dream” drove millions to making real estate purchases that will haunt them for years. T.V. shows even showed buyers missing opportunities because they waited mere hours before making an offer….only to lose their dream home to competitor buyers.
- Our biggest financial fear is losing something we have worked hard and a long time to gain. It took Martha years to save $50,000 and now her advisor wants her to invest in something other than insured CD’s. The two words “guarantee” and “risk” polarize many into running from risk with not even a hope of objectively looking at both ends of the spectrum.
- When we perceive a lack of risk, we get greedy. The primary emotional response would be GREED or ENVY.
- While fear may have driven some to make purchases during the real estate bubble, others purchased because they thought they could make a killing. “Flipping homes” became slang driving many to purchase homes for nothing more to hold, make a few improvements, then sell in an ever rising market. These individuals were in for one thing…..$. When values dropped, these individuals walked away with no regard to property since they intentions of living there anyway.
- During the tech bubble many became millionaires….at least on paper only to lose the same during the bust. Companies with poor business plans, no profits, and tech savvy captured millions in investments and market capitalizations kept climbing. Not many talk when they lose money, but there’s plenty of yak when it’s being made. A conservative investor looked like a fool for not being overloaded with tech stocks that had astronomical gains, and your neighbor let you know every day! So many envied those easy gains and wanted the same…..and ultimately became a victim of greed.
- Envy drives many into consumer purchases that are simply luxury items. Marketing uses the same emotion to create perceptions of what is successful and what is not, and then turning that into sales.
- Other emotions have equal and powerful influences over us. These include:
- Pain
- Anger
- Love
- Passion
- Joy
- Shame
- Guilt
Disciplining yourself to recognizing emotions and removing risk perceptions is challenging. Certainly a good advisor can help you through the process and more importantly is there for support during those times when “emotions rule”. Ultimately, mastering these concepts can help you make decisions without being encumbered by emotions like the “fear of making a mistake”.
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