As every investor should know, there are circumstances when we should definitely not trust our emotions.
For example, when everybody is in a frenzy to buy or sell and we feel a strong pull to go where the flock is going. Our emotions are likely following a primitive pull to stay with the safety of the group.
Or when our rational mind tells us to get rid of an investment, but we’ve had it so long that we’re attached to it and won’t sell. We’re likely following our tendency to stick with the status quo.
However, there are also times when our emotions are signaling something important and we should pay close attention.
Let me give you an example from a client of mine who we’ll call Jim…
Jim awoke in the middle of the night in a panic. He realized he was in big trouble with his crypto “investments” and had to take some fairly drastic measures to set things right.
But it would be expensive. He and his family would have to adjust their standard of living.
The anxiety and dread were nearly unbearable at 3:00 in the morning. Jim desperately wanted to get away from these emotions and, fairly quickly, the soothing balm of denial began to work its magic…
This can’t be as bad as I’m feeling. I must’ve had a scary dream and I’m mixing up my feelings from the dream with my worry about my investments.
The sell-off is temporary and is sure to bounce back, saving me from being overleveraged.
Things have been fine so far. It’s likely they will be fine again in the future.
Finally, Jim was able to calm his anxiety and get back to sleep. When he woke up, he dove into his day, content that he’d worked through the trouble that had awoken him.
But, of course, he hadn’t. And the trouble was still every bit as urgent.
In this case, Jim’s emotions were actually stemming from his accurate knowledge and understanding of the situation.
There were facts that he knew from his analysis, but he had avoided putting them together because he didn’t want to face the truth.
But while he was sleeping, his mind had assembled the puzzle against his will.
His panic was justified, and it was trying to tell him something urgent. He needed to take action now.
In this case, Jim’s emotions were telling him that he was in danger. He’d been avoiding important information that pointed to a potential financial disaster.
He’d been ignoring it long enough that his emotions took the form of panic.
If he had been paying attention earlier to his mild sense of anxiety instead of pushing it aside, there would’ve been no need for the panic.
But isn’t this following your gut, which I’ve warned against before?
No, this is different.
Awareness of our emotions does not mean blindly following them.
By paying attention to our emotions, we can decide whether there may be some action we should take to improve whatever they may be signaling to us.
There are many ways that our emotions can mislead us about investing. Exploring these is part of what I’m doing in these columns…
But that doesn’t mean we should ignore our emotions… or deny them.
Primarily, emotions are guides that help us learn and grow from situations, and they’re most often about what we should do next.
But as with the examples above, our emotions can also mislead us, directing us away from clear thinking. We need to listen to our emotions but integrate them with our rational thinking.
Here’s the difference in this case: Jim’s emotions were telling him to pay attention, to dive deep into the details of his investments, to use his rational mind to put together the pieces he had been avoiding and to solve what had become a very big problem.
They weren’t telling him to jump into – or out of – an investment in spite of the conclusions of his rational mind.
Jim had actually been following his gut by believing the happy feelings that were generated by the story he’d created for himself – the story that told him everything was okay. He was using those feelings to avoid clear thinking.
His panic was yelling at him to look at the knowledge he had.
The good news is that eventually, after a few rounds of being awoken by panic, he paid attention and took a clear-eyed – and very painful – look at his situation.
As his life coach, I talked about it with him. And I helped him face some difficult emotions, including shame, embarrassment and regret.
He made some painful decisions that involved selling things he really didn’t want to sell.
This affected his standard of living for a time, but it also ultimately allowed him to stop the bleeding and get his finances back in shape.
This was hard, stressful work. Most people would’ve preferred to avoid going through it. But facing up to it in the present was better than dealing with a much worse situation later.
And that’s the most effective use of our emotions.
In investing, blindly following our emotions can lead us right off a cliff because they are not generally wise guides.
Their information can sometimes be very accurate. But it can also become very skewed by the stories we weave, the things we desperately want to believe, the pull of popular opinion or the strength of our habits, good or bad.
Our emotions are essential. They give our lives meaning and are central to our decision making.
People who have lost the capacity to experience emotion have also lost the capacity to make effective decisions.
To become a better investor, trust your emotions. But do so only when they are in concert – not in conflict – with your rational thinking and analysis.