I can think of a few times over the last several years where emotions got the best of me and led to some bad investing decisions. The first was in late 2009. I keep an account with a focus on short to mid-term trades. The stocks in that account were all doing extremely well and I got a little cocky. I made some trades that fell outside of my strategy for that account and the results weren’t pretty, actually they were quite ugly. It wasn’t a total catastrophe, but I should have known better. The second time was in the beginning of 2012, the stock market was roaring and so was one of my key portfolios. I got overconfident (in the market) and didn’t protect my gains. What followed was me watching the back end of an out of control train rolling downhill; it’s taken me an entire year to recover from that mistake. So what happened in both of these situations? The short answer is that I let emotions get in the way of logic when making my investment decisions.
One aspect of investing that is often overlooked is keeping emotions out of your investing. Being an emotional investor will usually end in disappointing results. What is an emotional investor? In its most basic form, an emotional investor can be described as anyone who makes investment decisions based on emotions. Fear, confidence, exuberance are just a few of the emotions that can lead to bad investment decisions. Here are a few examples of emotional investing that should be avoided.
The Panicked Investor
Here’s a single sentence that can describe the “Panicked” Investor. “Sell Low and Buy High”. If it sounds contrary to a good investing strategy that’s because it is! Unfortunately, many investors have a tendency to panic in a down market and liquidate positions, often at a loss. Meanwhile, astute investors are carefully gaging the market correction. They’re doing their homework and finding stocks that are undervalued to add to their positions. This would also be a good time to dollar cost average on some positions.
The Timid Investor
The timid investor is closely related to the Panicked investor. In fact, the panicked investor quite often becomes the timid investor. The timid investor will sit by the sidelines as the market bottoms out. They’ll miss good buying opportunities and quite often turn away from the market altogether. At least until they realize that letting their money sit isn’t growing their portfolio. At some point there will be positive economic news, articles will flourish about the market doing well, and the financial news will be awash with glowing praise of the markets performance in the coming year. Unfortunately, this is when the timid investor will probably jump back into the market, when it’s well into an upswing. Remember the term, “Sell Low and Buy High”?
The Overconfident (and at Times) Greedy Investor
I’ve found myself in this state of mind several times over my investing career. It typically happens during a bull market. It seems that anything you touch jumps up in price. You get so excited that you forget that a bull market is a good time to take some money off the table or at least set some stops to protect your gains. Somewhere in the back of your mind a belief is born that you are a budding fund manager. If you keep up with these gains one of the brokerage houses will surely beat your door down to get you to manage the “Super Duper Crazy Return” fund. You continue to ride the up market. As your confidence increases (and your head swells to the size of a blimp) you start buying stocks that are risky and fundamentally overpriced. You don’t put stop losses on them. You let everything in your portfolios ride the upswing.
Then, unless you work in the securities industry, work (or other matters) keeps you away from your portfolio for a few days. At some point you notice that there’s news about a market correction. You login in to your brokerage account and notice there’s a train wreck in the process of happening. You start bailing out of positions. In a panic you even sell solid securities that are worth holding through the storm. Here it is again, Sell Low and Buy High.
The Lovestruck Investor
Last but not least is the investor that falls in love with a stock. It may be because of a profound belief that the widget they’ve come up with will solve world hunger, or it may have been a once healthy company that has fallen on hard times (I may write an entire post on my MCI Worldcom and AIG debacle some day). Whatever the reason, the investor “falls in love” with the stock and continues to hold on to it. At some point the reality sets in, usually when the commission to sell it costs more than what you would sell the stock for. I have a few stocks like these sitting around. They serve as a stark reminder on how not to invest.
How to Avoid Being an Emotional Investor
Set a strategy and stay with it! A key to being a successful investor is to have a strategy. With the goals of a particular portfolio in mind, develop a guideline on what kind of securities you will invest in and how long you intend to hold on to them. Set guidelines for when you will buy and under what conditions you will sell securities in that portfolio. Use Stop Loss Orders! Even when first entering into a position, this limits your exposure and they don’t cost anything! If you’re worried about missing on potential gains (don’t get greedy!) then use a trailing stop loss order. Above all, write your strategy down! Writing it downs gives you a baseline of how you should act to support your investment strategy.
If you find yourself contemplating moves that fall outside of the strategy you’ve set, then you’re probably on your way to becoming an emotional investor. Read through your strategy and ask yourself if what you are contemplating falls within the guidelines or not. I know this has helped me immensely and kept me from making some pretty dumb investment moves.
A parting thought: We are in the midst of a terrific upswing in the stock market; everything seems to be doing well. Have you taken steps to protect your gains? Are you taking some money off the table and using stops (trailing or otherwise)? If not, now may be a good time to do some homework and safeguard your portfolio. I’d be interested in hearing about any experiences you may have had with emotional investing, please comment and share them.