Are we emotionally intelligent in investment decisions?


Are We Emotionally Intelligent Enough In Making Investment Decisions?

As we navigate these turbulent times of uncertainty, we are constantly under pressure to call shots on which investment to make and which investment strategies or styles to use to enhance the returns for our long term investment.  As we are advised to brace for the impact of increasing market volatility, inflation and interest risks while investing, we are dissuaded from investing based on rumours. We are always cautioned to conduct more analyses with facts after verifying from trusted sources such as Bursa Malaysia, Bank Negara Malaysia and Securities Industry Development Corporation (SIDC) before investing. In the past, we may pin the blame on rumour mongers and the lack of information for our inability to invest well. But with more information available now, are we more prolific in making informed decisions that produce better investment outcome?  While some of us are instilled with knowledge for investing, some still perceive investing as a daunting task. Inevitably, many of us are still prone to making suboptimal decisions despite religiously adhering to tips from the pundits. This is because making the right choices also becomes trickier with an ever increasing assortment of financial products to suit our investment palates.

We are also reminded by the investment community to keep our emotions in check when investing. This is because emotions can lead to perverse and suboptimal decisions in investing.  We feel lousy and we may blame it on luck to make us feel better while some of us became mentally depressed when things turn out badly. Some of us cringe at making investment decisions and shy away from financial products after encountering some painful experiences in the past.  Thus, can we ignore our emotions when investing? If not, do we need robo-advisory services or digital asset manager proclaiming on investing without emotions to help us in making the right investment decisions? On the other hand, according to research, not exhibiting the appropriate emotions could impair our ability in making decisions.

So, why are we so hard on ourselves? After all, we are emotional creatures. We can’t possibly ignore our emotions when investing. I suppose if we could understand our emotions and what drive our emotions in the process of decision making, we could be less subjected to unhealthy thoughts.

As decision making is a complex process, we tend to use mental shortcuts termed as “heuristics” by psychologists to solve problems instead. According to psychologists, we simply make judgements and decisions by consulting our emotions. We ask ourselves i.e. ‘Do we like it? Do we hate it? How strongly do we feel about it?’ We form opinions quickly, make judgement and take risks as expression of our feelings on the basis of mental images without realising why we are doing so. 

Researchers suggest that our brains exhibits tardiness in adjusting our impression once our mind has been framed. Festinger posits the “theory of cognitive dissonance” and encapsulates that we will try to look for information that reaffirms our initial opinions so that the opinions that we form earlier do not contradict the information that we receive later.  This somewhat explains “confirmation bias” and “first impression bias”. This could also explain why we may fall prey to financial scams.  Scammers who have positive image and good in manipulating our emotions with words that mesmerize us are more likely to gain our trust. To avoid becoming an easy target by malicious people, we may need to think like scammers and try to beat them at their own game. Of course, we are not advocating that we act like scammers but playing defence all the time in their game can be tiring. We need to play like a striker as the situation warrants it or find ways to change the playing field when dealing with scammers.  In short, as we could not possibly suppress or ignore our feelings and emotions, we have to try to manage our emotions. Numerous books and articles offer tips that we could adopt to improve and practise our emotional intelligence.  

Our decisions can be also easily affected by our mood. The effect of mood on decisions is well documented in journal articles. When we are in bad mood, we tend to be more pessimistic about the future.  We are more likely to invest in risky assets such as equity and conduct less critical analyses when we are in good mood which predispose us to underreact to negative information about our investments. Besides this, there are many interesting journals and articles on weather effects on stock returns in the west. For instance, Hirshleifer and Shumway in their Journal titled “Good Day Sunshine: Stock Returns and the Weather” have unearthed that our financial decisions may be affected by sunshine. Sampling 48 developed  and emerging countries, Yuan, Zheng and Zhu in their studies titled “Are Investors Moon Struck?- Lunar Phases and Stock Returns, advanced the notion that the performance of the stock exchanges is significantly higher during the new moon.

Thus, unless we are emotionally intelligent, we may not be able to make wise decisions even if use digital asset managers for investing. But again, do you think we will be happier if we don’t use heuristics but instead utilize and filter reams of information before arriving at a conclusion? Researchers contend that conducting too many analyses may also lead to “analysis or information paralysis”, a situation whereby we are unable to make decisions or reach a conclusion due to information overload.

External Education Advisor - Dr Audrey Lim
Dr. Audrey Lim Li Chin
Lecturer & a researcher at Multimedia University (MMU) Melaka | Certified Financial Planner (CFP)

Source: Smart Investor Nov / Dec 2022