How Emotions Can Take a Toll on Your Investments?

“Animal Spirits” is a term that was coined way back in 1936 by a British economist, which stays relevant to stock market investors even today. In fact, more than ever before. 

John Maynard Keynes wrote about this term to explain how emotions affect our investment decisions, especially in times of economic uncertainties. When the markets are volatile, we tend to take investment decisions on the basis of our emotions, rather than on the basis of pure economic rationale. And it doesn’t need to be said that such emotional decisions won’t bear us the fruits that we invested for.

That said, let’s take a look at how emotions affect our investments and what we can do to make sure they don’t. The emotions that primarily drive investment decisions are overconfidence, hope, fear, and pessimism. Let’s look at them individually.

1. Overconfidence

Overconfidence can be dangerous in any aspect of life, but its effect can be the worst in investing because it can actually lead to the loss of wealth. Overconfidence comes when investors think that the market volatility or certain economic occurrences won’t affect their investments. This leads to decisions made without taking these events into consideration.

For example, you, as a retail investor, might think that some changes to the Goods and Services Tax (GST) will not affect you since you don’t run a business. But, this overconfidence leads you to forget that even though you don’t run a business, you have invested in many businesses that will be affected by GST changes. Hence, your overconfidence can lead you to take an investment call that will hurt your portfolio. 

What you can do: Don’t allow yourself to become a victim of superiority bias. Understand that there are a lot of things beyond your control or knowledge that can have an impact on your investment portfolio. So, don’t turn a blind eye to them.

2. Hope

Hope springs eternal, right? People will keep on hoping, no matter the circumstances. When it comes to investing, such hope shows up when we continue to hold onto investments that are continuously doing poorly, in the hope that someday they will do well again. What does this lead to? Losses after losses.

For example, let’s say you had invested in stock ABC when it was at Rs 100. Then, the stock fell to Rs 80, but you didn’t sell because you hoped it would recover with time. That Rs 80 went down to Rs 60 and then Rs 50, but even as the stock lost value, you didn’t lose hope. But you did lose out on a lot of money by not booking losses when the stock started to fall.

What you can do: Wait for an investment to recover, but don’t wait for too long. Evaluate the company to understand what is going wrong with its business. Figure out if the stock actually does have the potential to turnaround or not.

3. Fear

The fear of not doing something well often leads us to not doing anything at all. In investing, this can be related to not investing in equities because equities are volatile. The fear of losses will not allow you to invest for long-term benefits.

For example, we keep seeing headlines about the Sensex and Nifty going up and down literally every day. The news about Sensex going up by 500 points doesn’t have as much of an effect as the news about it going down by 100 points. You postpone investing because you fear that the markets will fall on the day after you invest.

Also, the stock market crash could be a good thing for investors, Don't believe us? Read: An Investors Guide to Stock Market Crash

What you can do: Ignore the daily gyrations of the stock markets. What is happening in the stock markets today doesn’t really matter much when you are investing for the next 10 years. Keep a long-term view and don’t be fearful of short-term movements.

4. Pessimism

Is the glass half-full or half-empty? It’s half-empty if you are pessimistic about investing in the stock markets. Numerous investors don’t invest in equities because they are unable to form a long-term view. They don’t expect anything good to come out of equity investments and hence, miss out on creating wealth.

For example, when you see short-term volatility in the stock markets, you become pessimistic about its long-term fortunes. You will hear a story or two about someone who incurred losses and without understanding the context, you’ll deduce that equities are extremely unsafe and no good for you.

What you can do: Look at data on how equity investments have performed over the long-term. Choose your investments wisely and hold onto them for the long-term. 

These are the major emotions that can play havoc on our investments. Being emotional is a quality to cherish, for sure. But maybe when it comes to investments, keeping emotions at bay is a better option.