Are Investors Emotional Or Rational In Their Investment Decisions?

Let’s start having a look:

The complexity of investment decisions has always made me feel whether investors made objective and rational decisions or were they swayed by their momentary emotions and psychology. The study of behavioral finance or how emotions and psychology influenced the way investors invested made me aptly think, “We can take the horse to the water, but can never force it to drink.” Even investment advisors can guide, but can never rule over investor’s emotions, and such emotions influenced the wrong choices or right choices they made, as also other investors decisions for wealth creation.

A bird’s eye view at common irrational investment behaviours:

Follow The Pied Piper:

It is quite right, these investors believe it is better to follow what others do, and they do not use their own discretion or rationality and just follow what others do and may be just pushed into the river as the rats with Pied Piper. This behavior influences market trend of investments greatly with sudden crashes after a rise, with certain wise and shrewd investors like Pied Piper making huge wealth by selling at the right time. You would definitely find at least one wise investor, who said, “I always told you to buy when everyone sold and sell when everyone bought.”

I always know and knew everything:

I-know-everything attitude can prove to be as destructive to wealth creation as following the Pied Piper. It is true that just like dictators as Hitler had a great fall due to lack of public opinion, lack of humility and patient analyzes by dialog and practical thinking makes these investors dig their own grave with their investment decisions at times.

I have always held these shares, and they can be good:

This behavior of holding on to something known, for fear of the unknown just like a baby holding on to his/her mother on the first day of going to a pre-school, is bad, as even a child realizes after a few days in school. Similarly holding on to certain investments because of the low price-earnings ratio, or being well-known companies may prove wrong when the company is sinking. It is true this chronic anchoring, without a fresh look at ones investment decision based on the play of market forces could even make one suffer huge damages.

I will not lose it will pass:

To avoid surgery just because it may be a failure, or it is better to wait and see is just like holding on to shares of companies running at a loss with the hope things would improve. It is possible that such good times are just an illusion, making one suffer huger losses and greater psychological impacts for life.

However it is quite likely that these lower prices could also be an indicator to buy by systematic investment/ systematic transfer plans and accelerate wealth creation with averaging. Hence an incliantion to learn and grasp basic investment principles and shrewdness to judge the nature of share price decline, whether it is temperory permanent can help make a wise investment decision.

Making a moutain out of a molehole:

Rationality escapes investor’s mind, which over-react to good and bad news. The recession during 2008 made most of the investors over-react by selling their shares and mutual fund units thinking that the recovery will take a longer time and they lost in the bargain.  Similarly, sometimes certain unscruplous investors spread wrong news about the profitability of certain ventures, with amateur investors over-reacting and investing all their savings in dupious ventures. The only advantage that such over-reaction has given is  when one gets to invest in good value shares that appreciate in the long run.

Sentimental and emotional attachment to the holdings:

At times investors become sentimental with a particular share or a portfolio and they don’t want to sell those shares in any situation. One classic example is inherited investments.

You may agree that sentimentality, being too attached to inherited investments without gaining from the uptrend trends is what fools do. It is true we inherit profitable investments from our parents, but if they cannot be encashed at an appropriate time, considered as a blessing and used, I see no reason for inheritance at all.

Another classic example for this sentimental holding is ESOPs.

Some other based and baseless investment behaviors:

Look out for ceratin other investment behaviors like

1)  Attachment to certain investments of a similar nature

2)  Comfort zone for certain familiar set of investments,

3)  Investments based on recent favorable or unfavorable happenings in the market.

These attitudes will make you biased in taking investment decisions. So you need to be more careful in dealing with these attitudes when taking investment decisions.

The ultimate word:

These are just guidelines for rational and goal oriented investment decisions. Happy Goal oriented Investing with Wealth Creation.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Founder and Director of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.