It is easy to get caught in an emotional trap with our investments and
this tendency can lead to poor decisions as we fall prey to our hopes and fears.
In over 15 years as a financial advisor and teaching investing classes, I have
found that most investors make investment decisions based upon emotions because
they suddenly become interested in learning about investing and start buying
stocks when the stock market is surging higher only to panic and sell when
markets are declining.
By reacting emotionally, these investors quickly find themselves trapped in a
destructive cycle of buying when the market is high and selling when the market
is low that reduces their ability to get the most out of their investments - let
alone earn a profit from them. Over the years I have taught lawyers, doctors,
engineers and even housewives. Most have told me they have failed to make money
when they invest due to their emotions taking over and getting in the way of
sound decision making. Understanding the emotional cycle humans experience
during a business decision or investing is important to consider.
The Cycle of
The typical emotional investor response to market movements is best
characterized as a cycle of rollercoaster like emotions. In this cycle, the low
phase actually corresponds to the “point of maximum financial opportunity” while
the high phase corresponds to “point of maximum financial risk.”
Emotional investors (or those who have previously lost money in the stock
market) will often not enter or re-enter the market until they believe it is
safe - usually when stock prices are already well into a bull market. And while
the stock market may still climb higher at such a point, these emotional
investors have usually missed the best opportunity to maximize their profits
Likewise and when the stock market is falling (or collapsing as they did at the
height of the financial crisis in 2007-2008), emotional investors enter the
“desperation” or “panic” phase and either dump their stocks or hold on to them
only to enter a state of “despondency” or “depression” when the temptation to
sell is often too great. The media is your enemy at this stage and often cites
how it is different this time and the rules have changed.
At that point in time, wiser or more experienced investors will take advantage
of depressed stock prices and either get into the market or add to their
existing positions in quality stocks that are trading at steep discounts only to
sell them back to emotional investors who inevitably reenter the market when
they think its safe to do so and after prices have already bounced back by a
considerable degree. Take a minute and reflect on the low of the 2008 financial
crisis, the news was depressing and panic all around yet the US S&P 500 is up
150% , the technology sector (QQQ) up 200% from the low and many individual
stocks much higher, Apple +500% and Priceline.com up over 1000%.
Part 2 of the article will be continued next week.
Don Freeman is president of Freeman Capital Management, a Registered
Investment Advisor with the US Securities Exchange Commission (SEC), based in
Phuket, Thailand. He has over 15 years experience and provides personal
financial planning and wealth management to expatriates. Specializing in UK and
US pension transfers. Call 089-970-5795 or email: [email protected]