Letting emotions get the better of you when it comes to investing opens you, and your money, up to all kinds of trouble.
It can be all too easy to get excited about a high-performing stock as the next "big craze" and jump to rash conclusions thinking, "Wow! I can multiply my return 100 times over and pay off the mortgage".
On the other hand, getting frustrated with a stock when it hits a low may convince you to sell out of fear it will never recover. There are all sorts of thoughts that can come into play when emotions get involved with investment decisions – it's honestly one of the worst things you can do.
But what about emotion when it comes to the core values of the individual whose money is being invested? Is there a place for ethics when it comes to making investment decisions?
This article will shed light on these questions. I will also help you to recognise the dangers involved when emotions do get involved so you can avoid making some costly mistakes.
An emotional bandwagon
“If you see a bandwagon, it's too late.” – James Goldsmith
One of the big issues that arises when we make emotional decisions is the tendency for people to allow their greed to push them forwards. It forces them to make decisions they wouldn't otherwise make. When a stock performs exceptionally well, it can be all too easy for the average personal investor to get excited about making quick money and jump on the bandwagon without giving it much thought.
If it looks too good to be true, it could be
There have been a great many bubbles in the past that have encouraged emotional investors to throw money at them. In the early 2000s, a very similar thing happened with technology stocks. After decades of meteoric market growth in the ‘90s, everything appeared to crash. Essentially, technology stocks were being bought by people who do not usually invest, causing absolute mayhem in the stock market.
The bandwagon had well and truly set sail, and there was no going back.
People started investing heavily into assets such as tech companies that had no turnover, no stock, nothing behind it. The same thing happened 17 years later with Bitcoin when in the space of twelve months, Bitcoin’s stock value dropped.
In the world of investments, the truth is if something looks too good to be true, then it usually is – trust in James Goldsmith and avoid the bandwagons.
Emotion - buy higher, sell lower
Investments that appeal to people's emotional side never really serve any use. For example, an emotional investor, because they are looking backwards, may buy into assets that are very high because they haven't considered where that stock will be in the future. Additionally, emotions would cause that same investor to sell low when they shouldn't have.
In 2007, if you'd have sold your investments at the bottom of the markets, you would have missed out on more than a decade of tremendous market growth before the pandemic. Either through greed or fear, it is emotion that would have dictated all of those incorrect actions in 2000, 2007 and 2017.
Pragmatic sense doesn't come from self-managing your investments
Pragmatic sense would take a far more efficient approach. If a stock has gone up 7 or 8 times over a year, as Bitcoin did, do we want to buy that high? Where is that stock going in the next 12 months?
Using a pragmatic template would have also discerned that at the bottom of the 2007 credit crunch, the tech bubble-burst in 2001 and now during the 2020 pandemic, to invest more. Double down on the equities that are cheap, but do it correctly, with advice from an experienced adviser. I explain more about this in my previous blog, The Makeup of a Successful Potfolio, so feel free to refer to that for more information.
This pragmatic sense never usually comes from an individual managing their own money. It comes from a financial professional that takes a pragmatic view of the world, and if they are good enough, a pragmatic view of the future, too.
So when it comes to managing investments, my advice would always be to use an experienced independent adviser. Don't let your investment decisions be based on human greed. In most cases, it only causes the individual to get caught up on bandwagons, fads and in the worst cases, false promises and scams.
Ethics – do they have a place?
So far, I have made it clear that when it comes to buying and selling, emotion should always take a back seat to the pragmatism of a good financial adviser.
However, what about emotion when it comes to personal values? Do ethics inform investment decisions? Should we let our values stop us from investing in stocks that can give higher returns?
Traditionally, an ethical suite of bonds hasn't performed as well as other funds. Look at the oil industry as an example. It may not be the most ethical industry, but we are still very much in a world where we need oil everywhere, and as a result, it makes a massive amount of money. If you are in the investment world to make money, then naturally you're attracted to what will provide the best return, right?
The truth is the world cannot go round without something unethical cropping up. That organic, ethically sourced orange you buy has most likely been driven around in a diesel-fuelled truck, with oil-based rubber tyres. Unfortunately, it's not always avoidable.
But there is a place for ethical investment, too. In the world today, we are more conscious than ever of our carbon footprint, and this does play a role in investing. Some ethical funds have done tremendously well, investing in the growing popularity of green energy, but it's still a small market when you compare it to other funds.
Ethical investing with a pragmatic view
Of around 6,000 funds available to buy, the amount of them that are ethical are into the mere hundreds; there just aren’t many ethical things to buy. So what does that mean for diversity and a successful portfolio? When it's your retirement at stake, is it really worth taking this narrow viewpoint?
If we are to make ethical investments, we should look at it from a pragmatic, rather than emotional viewpoint, in my opinion. If we do so, there are investments out there that can create diversity to traditional assets. The oil industry is a great example of an industry that has made money, isn't ethical and at some point in the next 20-50 years, may be gone.
So you can be optimistic that more ethical industries like solar will be much larger than they are now and this presents an excellent case for diversifying into them. Ultimately, however, it's still about looking at it from a pragmatic view and making decisions that will make you the most money.
Smart investing is about following money-making machines like oil but also understanding when to branch off and diversify into smaller markets that will become mainstream in the future, like solar.
And that's why it’s best to speak with an experienced financial adviser. When we start letting emotions dictate our decisions, mistakes happen. So if ethics elicit an emotional response to the investor, do they have a place in investment either?
I hope this was useful. Feel free to comment with your thoughts and opinions, and email me directly for any further information at firstname.lastname@example.org.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article, or alternatively contact the Applewood Independent Ltd office on 01270 626555.
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