When we think of investing, many us ignore the emotional aspects. After all, we’re told to leave emotion behind when putting together a portfolio. All too often, though, our choices are made with emotion.
Two of the most common when it comes to investing are fear and enthusiasm. While small amounts of each can actually help your investment strategy, it’s important not to get too carried away with either.
Downsides to Fear
In some cases, a little fear can be healthy. A small amount can result in caution, keeping you from taking unnecessary risks with assets you aren't particularly knowledgeable about. If worry keeps you from trading the EUR/USD on margin when you don't know what those letters mean, fear isn't a bad thing.
But fear becomes dangerous when it turns to panic. Here are two examples of how fear can cause portfolio problems:
- Selling low: We know we’re supposed to buy low and sell high. However, when the stock market is falling and everyone around us is selling as talking heads in the media predict doom, it’s easy to let the fear take over. Instead of selling based on fear, take a step back. The market may be dropping, but is your investment still fundamentally sound? If so, chances are that now is not the time to sell; your investment will likely pick up later, when the market recovers.
- Investing so you don’t miss something: Fear can also prompt ill-advised purchases. Are you afraid that you are going to miss a “hot” opportunity? You might invest in something just before the bubble bursts because you are so afraid that you are missing out on something “everyone” knows about.
In both these cases, you are afraid that you are missing something that crowd knows about and you don’t. The best way to avoid making decisions based on fear is to step back, and ask yourself why you want to buy or sell.
If your reasons have little to do with the investment itself, and how it fits into your long-term goals, and more to do with low-level (or even high-level) panic about what other people doing, and whether you are doing the “right” thing, you might want to reconsider your decisions.
Problems with Enthusiasm
Honestly, it would be great if more people were a little more enthusiastic about investing. At least, it would be great if they were excited about building wealth with the help of carefully chosen investments. However, being excited about investing is completely different from basing your decisions on enthusiasm.
Excessive enthusiasm can lead to problems with your portfolio, especially if you become too caught up in a particular investment. If you let your feelings of happiness run away with you when an investment does well, it can be easy to overload your portfolio with a particular investment, asset class, or sector. This can throw off your asset allocation as you lose site of your goals.
Also, don’t take success too personally. When you do well (along with the rest of the market), it’s easy to think you’re an investment genius. This can lead you to feel as though you can take bigger and bigger risks, since you “know what you’re doing.” Eventually, this sort of enthusiasm catches up to you—and when your risky bet turns out to be a bust, your portfolio could suffer.
Temper your enthusiasm, and remember that success doesn't come only from your investing savvy. As with conquering fear, the key to conquering excessive enthusiasm is to take a step back, and do your best to push most of your emotion away as you evaluate your investment choices.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.