Media hype during market peaks and troughs can sometimes lead people to buy and sell investments without thinking decisions through properly.1
Speculation among friends, family and co-workers as to what’s happening in markets can influence investors to ‘pull out early’ or ‘test the waters’.2
Jeff Rogers, chief investment officer of financial advisory firm ipac, says making impulsive investment decisions based on media hype and fear is what’s known as ‘emotional investing’.
We spoke to Jeff in more detail about what emotional investing is and what it could mean for you financially.
1. What traits do emotional investors display?
Emotional investors tend not to have established savings goals or a long-term plan for their investments. Their style of investing contrasts to an ‘objective’ or ‘disciplined’ approach where an investor tries to focus on the facts pertaining to an opportunity, rather than how they’re feeling.
As markets go up, emotional investors often move from optimism to euphoria, looking to buy more. Then, when markets go against them, their anxiety grows. They eventually become despondent, embarrassed about being invested at all, and are prepared to sell at almost any price.
2. How common is emotional investing in Australia?
Australians have historically been less exposed to emotional investing than some overseas counterparts. Perhaps this is because much of the savings in Australia is implemented in the superannuation system, which has been built with a long-term focus in mind.
In other parts of the world, including the United States, investors buy and sell quite frequently and there’s considerable evidence that emotions dominate decisions to the detriment of long-term outcomes.
We need to remain alert in Australia where a combination of easier online access to trading in currencies and shares, together with the rise of self-managed super funds, might create additional risk.
3. How does emotional investing affect investment outcomes?
Generally speaking, emotional investing hinders investment outcomes because it can create a tendency to buy lower quality assets, to buy at higher than normal valuations or to sell at lower than normal valuations.
If you’re aware that a number of investors are transacting in response to media hype, it may be possible to take advantage of that by sticking to a well thought out strategy rather than acting with haste.
4. How do fluctuating markets impact emotional investing?
Volatile markets and strongly trending markets (either up or down) increase the propensity for emotional decision making.
When the markets are the centre of attention in the news, knocking sports stories and politics from the front page, emotional investors can get caught up and make investment decisions based on this hype.
5. Could a sound investment strategy be part rational and part emotional?
Humans are emotional beings, so an investment strategy needs to take that into account.
It helps to very clearly articulate the various investment goals of an individual or a family and to understand the level of priority around the attainment of each goal.
Strategies can then be developed with the best chance of achieving each goal without substantial risk of provoking a mistimed emotional response on the journey.
6. What other factors should people be aware of?
Ongoing quality financial advice can help investors reduce the risk of poor outcomes due to emotional investing. A key role of a financial adviser is to help their clients fight the behavioural urges that are harmful to their long-term financial wellbeing.
ipac is a wholly owned subsidiary of the AMP Group.
1, 2 http://www.investopedia.com/articles/basics/10/how-to-avoid-emotional-investing.asp