RSSEmbrace Strategy to Manage Emotion
By Jim Farrish | August 12, 2008 | 2:07 PM | 0 Comments
Over the years we have been emphatic that investors need to build and embrace a strategy that allows them to manage their emotions. However, we have not spent time recently discussing the individual feelings that make up emotions. As has been noted many times, our focus is to break the market into pieces (sectors) so that we better understand what is driving the whole. It is important to break “emotion” into the driving pieces (feelings) as well since not all emotional outbreaks are created equally.
The New Webster’s Dictionary defines emotion as “any specific feeling as love, hate, fear, anger, etc.” Obviously, this list could be expanded to include any number of feelings. Of interest is that when you expand the definition of emotion by reviewing other sources, you find the recurrent use of such phrases and words as: strong agitation of feelings, physiological changes, reaction, disturbance, spontaneous, intense mental state, disturbance of tranquility and irregular action. Sound familiar? The interesting issue of note here is that not only do we experience emotions to varying degrees but we also react to that emotion in a variety of ways but none of the descriptions above seem to indicate a high degree of control. Rather, they indicate more of a reaction. In looking at your own experience, you will certainly recognize that your emotional reaction is different depending on the “feeling” that is in play. Love typically has a more docile “warm fuzzy” reaction versus anger which can be “unbridled and intense.” In other words, we experience emotion to degrees.
Logic on the other hand is defined as “the formal, guiding principles of a discipline, school, or science” or “correct reasoning.” We preach almost incessantly the need to use logic in your approach to your money and it is noteworthy that when the market is in upheaval that emotion is on full display. The contrast between the two words is as clear as it is between proactive and reactive.
When we take this discussion to the individual investor level, we are always reminded that investors in general are governed, especially at critical junctures, by emotion. This is reminiscent of a recent meeting with an investor who wanted to be more fully invested looking out three or more years. Despite significant conversation regarding volatility and near-term downside risk the investor was adamant about this posture. Three months later as the market sold off in June, not only did the investor not want to be invested in a three year targeted portfolio strategy…she wanted to be an income investor. What changed in three months? Emotions.
The three emotions that in our opinion most clearly impact investing are fear, hope and greed. Looking at them individually it is not difficult to see them at work. In periods of economic downturn and market erosion, fear drives the behavior of many people. The issues are numerous but often include fear of loss, fear of making a poor buy or sell decision, fear of missing out on something or some other related factor. We also see hope thrown into the mix as well. There is an apparent tendency to hope for an outcome. People hope the market stops going down, hope it never stops going up, hope to break even and so forth. The final emotion that is in the big three is greed. This one has an overriding effect that we have noticed. When greed kicks in there is almost no reasoning with an investor because it appears to them that nothing can go wrong.
Unfortunately, all of these emotions reflect a lack of discipline and logic by nature. When fear does not subside, hope fails and greed gets stomped on by the market, the overriding emotion seems to be panic. Panic is never a good thing. It leads to irrational or reactive behavior. This is why logic must exist in your investing and why a disciplined strategy is crucial. Panic is overcome or avoided by disciplined thinking or training. This does not mean that you will not experience emotion but it does mean that you will address issues proactively through the use of your system keeping emotions in check. This is why we emphasize the need to know why you are investing and use the tools available to you that keep your portfolio properly framed such as entry and exit strategies, targets, stop-losses and the like. The first step is recognizing you have a problem with emotions and then developing a disciplined strategy that works for you.
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