TBO.com - TBO is Tampa Bay Online

Don't Let Emotion Wreck Your Returns

ADVERTISEMENT

The Tampa Tribune

Published: December 16, 2007

Feeling rattled?
Stock investors have been through the wringer during the past five months, sweating through nasty market declines and savoring the recoveries that followed.

But just because you're unnerved doesn't mean you're a lousy investor. Here is how emotion affects investing, plus four strategies that should help you sidestep the pitfalls.
Taking The Heat
Make no mistake. Emotions can hurt your investment results. For instance, a study published in Psychological Science in June 2005 found that people with impaired emotional responses made more sensible financial decisions.

These folks, who had lesions on their brains that limited their emotional reactions, were more willing to take gambles where the potential payoff easily outweighed the potential loss. "When people with normal emotional reactions lost, they got discouraged and stopped gambling," notes one of the study's authors, George Loew-

enstein, an economics professor at Carnegie Mellon University.

Similarly, investors with a strong emotional reaction to market swings often buy and sell at the wrong time and may trade more, thus racking up hefty investment costs. Sound grim? The news isn't all bad.

Emotions can also help, supplying the motivation to focus on our finances, plan for retirement, save diligently and avoid excessive risk.

"Without emotion, we wouldn't be able to make the sort of trade-offs essential to our financial survival," argues Andrew Lo, director of the Massachusetts Institute of Technology's Laboratory for Financial Engineering. "The best traders aren't those without any emotional response. If you aren't risk-averse enough, you could end up blowing yourself up and losing all your money."

As you might gather, handling our emotions is a juggling act. Intense emotions can be helpful, making us more engaged in what we are doing. But to be successful, we also need to figure out what's going on with our feelings and then limit the impact, suggests a study in August's Academy of Management Journal.

"People who can pinpoint their emotions are less likely to be affected by them," explains Myeong-Gu Seo, co-author of the study and a management professor at the University of Maryland. This self-knowledge is part of a broader notion sometimes dubbed "emotional intelligence."

Getting A Grip

Not sure your emotional intelligence is that high? Try these strategies:

•If the market plunges and you have an overwhelming urge to act, do something sensible. You might send off a $100 check to your favorite mutual fund or rebalance your portfolio back to your target mix of U.S. stocks, foreign shares and bonds.

•If you are tempted to make big portfolio changes, get a second opinion. "Talking to somebody can help you avoid destructive trades," says John Ameriks, an investment analyst at Vanguard Group. That somebody might be a friend or a financial adviser.

•Automate your investing so you keep buying stocks during rough markets by signing up for payroll deduction into your company's 401(k). Also set up automatic investment plans in which money is plucked from your bank account every month and invested directly in stock funds.

•Try the "restart" strategy suggested by Loewenstein. Take your existing savings and set them aside in a diversified portfolio, such as a target-date retirement fund. Thereafter, focus your energies on building a new portfolio.

Your monthly savings will have a huge impact on this new account's growth so you will have the incentive to save. Your savings will likely also overwhelm any hit from a market decline. What if you make some foolish trades? Because you're dealing with only a small portion of your wealth, you won't do much damage.

Share this:

Loading Comments...

Email Print

ADVERTISEMENT