Emotion is a poor investment adviser
Our minds can play tricks on us — it even happens in investing. You can protect yourself and improve your results, though, by being aware of how your emotions may be affecting your financial decisions.
Psychologist and investor Nancy Crays has explained that our emotions are invisible advisers that don’t always act in our best interests. They can cause us to lose money in the market, realize smaller gains than we otherwise would, feel insecure or anxious or overwhelmingly disappointed, or even quit investing altogether.
Crays points out how emotions such as greed dominate bull market times, while fear directs us in bear markets. She explains that we learn that it’s not nice to be greedy, so we end up rationalizing our greed. It gets to the point where greed seems normal in a bull market. Here are some signs that you might be letting greed get the best of you:
• You feel responsible for all your gains.
• You’re expecting your holdings to grow more than 15 percent annually.
• You’re looking into riskier investments.
• You’re increasingly interested in hot stock tips.
• You can’t stand being left out of the action.
• You wish all your stocks were in the current best-performing industry or sector.
• You’re convinced that the market is different this time.
To counter these feelings, stick to your investment philosophy. Don’t follow crowds, and don’t buy indiscriminately. You always want to look for stocks that are good values, not just good stories.
Meanwhile, in a bear market fear can keep you from recognizing buying opportunities. It might cause you to sell when you shouldn’t. Look within yourself for signs of low self-esteem, depression, panic, guilt and feelings of powerlessness.
To survive a bear market, recognize your emotions, stick to your investment philosophy, and view the downturn as a buying opportunity.
Sticking to your plan is critical. Expect market upturns and downturns, and don’t let the emotions they generate derail your portfolio’s progress.
Ask the Fool
Q: When we buy stocks, how does the money actually get to the company? — A.W., Chicago
A: It rarely does, actually. Think of stocks as being a little like trading cards. When a company like Topps sells a pack of gum with cards in it, Topps gets its money from the buyer. But after that, the cards may be traded among many owners, with Topps never getting a penny more.
When a company first issues shares of its stock, in an “initial public offering” (IPO), it collects its money for them, based on their estimated value at the time. After that, the shares are typically traded on major exchanges. The buyers and sellers exchange money for the shares, and middlemen such as brokerages take a cut, but money doesn’t flow to the company. In fact, if the company pays a dividend, it will be paying out part of its income to shareholders each year.
Companies do occasionally execute “secondary” offerings of stock, and when they release those additional shares into the market, they do get paid for them. But after that, the shares once more are simply traded.
My dumbest investment
I took my unneeded, interest-free student loan money and invested some of it in eToys soon after its initial public offering (IPO). It was a good early lesson to learn, probably worth the $600 it cost me. I later moved to Seattle and decided to invest about $2,000 in a local company called Starbucks. A couple of years later, my dad implored me to sell my Starbucks stock, saying “his guy” told him I should sell it. I shouldn’t complain, because I did make about 250 percent on my money. However, if I’d held on to it like I’d wanted to, it would be worth more than 10 times what I sold it for. The last time I asked him for financial advice, he told me to sell the stock in question, adding, “But that probably means you should hang on to it!” — Jennifer T., Boston
The Fool Responds: Sometimes dads are wrong, even when they mean well. With IPOs, it’s often best to wait before investing, until the firm has a solid record of profitability and competitive advantages.