This article originally published in The Northern Daily Leader on 5 July 2014.
It is probably fair to say that the world of finance, and investing in general, suffers from something of an image crisis. Many people consider finance to be a dry, dull and uninteresting topic. They imagine mind-numbing days of gazing at numbers, tapping away at tiny calculators and getting excited about the fifth decimal in a number as long as your right arm. Those people working in finance are thought of as either fast-talking brash fat-cats, or cardigan-wearing introverts who love their spread sheets more than their families. In fact, this picture can be the complete opposite to an actual day in the financial markets. During my time at an investment bank in London in the 1990’s I witnessed frustrated traders smashing their telephone handsets on their desks as markets plummeted during the Asian financial crisis; on other days cigars and champagne were passed around the trading floor after another successful day of making millions for the bank. Life was anything but dull in that type of environment.
Somewhat surprisingly however, showing too much emotion can have serious consequences for your investments – our emotional biases can lead to very poor decision-making. In many ways the cardigan-wearing introvert is likely to do a better job of looking after your money than the fast-talking fat-cat. A clear example of this is the concept of loss aversion. Research has shown that most people feel the pain of losing money twice as much as the happiness they gain from making money. So rather than selling a poor investment at a loss and reinvesting the proceeds into an investment with better prospects, loss aversion pushes you to hang on to your dud investments in the vain hope they may one day recover. Of course, some investments never recover, no matter how long you wait. The smarter course of action is usually to ask yourself this question: am I prepared to invest more into this investment at its current price? If you aren’t, but you’re continuing to hold the investment, then you’re a perfect example of loss aversion. You can avoid loss aversion by ignoring the purchase price of the investment and simply dealing with it on its merits – it’s not easy but it can be done.
Cardigan-wearing introverts who are able to disassociate themselves from the emotional aspect of investing are likely to do better than somebody who lives by the seat of their pants, riding an emotional rollercoaster. So next time you’re casting your eye over your investments, try to concentrate on being as detached and emotionless as you can, your investments will thank you.