By Andrew DePietro GOBankingRates.com
WWR Article Summary (tl;dr) From misplaced hope to inflated expectations, our emotions can toy with our financial planning in ways we may not fully comprehend.
Investors are often torn between their guts and their heads. While there's nothing inherently wrong with consulting your emotions when making purchasing decisions, stock buyers do need to beware of relying too heavily on their guts.
Bank runs, flash crashes and stock market surges are just some of the ways in which emotions can impact the market for the worse.
"Perhaps the most important thing is to understand an investor's psychology will almost certainly work against them," said Curtis Chambers of Chambers Financial Group. "When times are good, everyone wants to buy. When things are bad, everyone wants to sell."
Here are four emotions you should watch out for in order to protect your investments.
ENVY Admiring others' financial successes is one thing. Envy, on the other hand, can easily put your investments at risk. Jealous of fellow investors' boons, individuals often attempt to duplicate the results with little success. Unfortunately, one person's strategy doesn't always fit another's life circumstances or monetary constraints.
According to Ronn Yaish, managing partner at Yaish Financial Services, investors often hear stories from friends, family members or co-workers about their latest investment scores. "The investor comes home after hours of festering and second guessing his investment plan and leaves dramatic communication for the advisor to call first thing about something urgent," Yaish said.
The investor then tells his financial advisor to copy a friend's investment, even if it doesn't make sense. Unsurprisingly, this tactic leads to losses and reinforces poor investing behavior.
Copying an investor's strategy is one matter, but keeping an eye on the competition is another.
"Studying a fellow investor's success is smart. Trying to copy and outdo him out of jealousy nine times out of 10 will get you nowhere," said Justin Kirk, an acquisition and investment associate and former portfolio analyst.
FEAR Fear is one of the most primal human emotions and plays a huge role in emotional investing.
"I find that fear is probably the most detrimental emotion," said Bruce Ailion, a real estate marketing expert. "It might be the fear that prevents making a good investment. It might be the fear that causes an exit at the first sign of trouble that prevents realizing the full profit of the investment."
While all investing involves some degree of risk, fear can drive you to risk too little and affect your ability to reach financial goals.
"My 32 years of advising folks suggests that the No. 1 mistake investors make is when they panic. I find that investors panic when they mistake a perfectly normal decline for a permanent decline," said Paul Ruedi, CEO of Ruedi Wealth Management. "It is fear, which causes people to act on an impulse and sell. Impulse is not an investment policy."
HOPE Just as being too fearful can jeopardize your investment success, being overly hopeful is problematic. Hope can turn negative when it inflates expectations. Whether you're a brand-new investor or one with years of experience, being too optimistic can lead you to take on too much risk with the idea of scoring a big payout.
Further, people who are too hopeful often experience something called recency bias, in which they assume that what has happened recently will continue to occur in the future.
"Studying historical data is important to investing, but you can become overly optimistic if recent data seems to support your desired outcome," said Kirk.
It's good to be optimistic, but having misplaced hope, or inflated expectations, can spell disaster for your portfolio.
STUBBORNNESS Believing in yourself is one thing, but stubbornness rarely pays off in the world of investing. In fact, stubbornness often inspires investors to purchase a stock that isn't ideal or stay with a stock that has already shown signs of dropping.
"Part of the problem people have with giving up hope is that they'd have to admit they were wrong," said Kirk. "If the investor were to sell it at a loss, they're admitting they made a bad decision. Worse, a bad financial decision. Admitting this is very tough for people. In reality, often it's best to cut your losses and move on."
It's good to have faith in yourself and your abilities. However, if you stubbornly refuse to listen to reason, you could quickly put your investments, and your money, at risk.