How emotions can effect investing decisions?

An article by pgupta

I recently had some conversations with people who are regular investors. We talked about various investment strategies and how various people trade. One thing that always intrigued me what makes a non-sofiscated investor put his hard earned money into the market? Teachers, call center employees who really earn in the range of 20k-30k in entire year, how do they decide to put 5k in the stock market? I have been asking around and one might be surprised by the fact that people mostly invest in brands which they are familiar with No kidding. So if you own a GM car, there is a very good chance that they will invest in GM stock We all know where GM ended up.

What drives people to invest in a particular company

So what drives these people to take such an action. May I dare to say “pure emotions”? Yes my friends, emotions drive most of the non-seasoned investors. My colleague who sits next to me at work, she said she invested in Walmart because “she knows that Walmart is a good company and that it will never go under”. Now who would have ever thought, ok let me re-word, would an emotionally driven middle man have ever thought that Lehman Brothers would collapse like that in a matter of hours!

People invest in brands they recognized

Now get this, Walmart in the entire last 12 months has gone up by 3.14%! If you are 20-something, do you really want 3.41% return on your investment from stock market. You can get that kind of return by opening a savings account with Citi or another bank. That is exactly what I am talking about when I say people invest out of their emotions not because of their logic oriented research.

There are several articles that you can find that talk about investing behaviors and various patterns. One of such article I found on Emotional Investing a Recipe for Disaster

When do people buy and sell stocks?

This is one thing which no one has a perfect answer to. I mean, how can you really tell when to sell or buy. But at the same time, experts who spend lot of time researching and playing their cards carefully can tell you that if stocks start to rise, do not just go out and sell immediately. Otherwise what is the point. You want to be part of the rally that will make your returns in double digits.

At the same time, do not panic if your portfolio suddenly starts to drop its value. Rather spend some time in evaluating how much money can you really afford to lose. That will determine your risk taking threshold and then set your STOP orders accordingly to limit your losses.

Put your emotions at check when you invest

Thats the bottom line, check your emotions when you are about to trade. Essentially check your fear to lose money and conquer your desire to become millionaire overnight. Calculate your risk taking ability and appropriate profit level for exit. If you fail to any of these, you are not meant for investments. Just go and sign for mutual funds or just put your money into savings account.