Richard Taffler: Emotions & Investments
Aligning an interest in the investment industry with an inbuilt technological skill set led Benjamin Irving to SuisseTechPartners, whose PMplus product, he says, is poised to deliver major cost and functional benefits to asset managers and their service providers.
How are emotions impacting asset management?
Emotional finance explicitly recognizes the vital role of emotions - conscious and particularly unconscious - play in all financial decisions and behaviors. More generally, it describes how we are driven by our unconscious needs which may often be hidden from us. This goes well beyond any rational behavior. It teaches us how we are not “rational decision-makers,” even if we want to believe we are. I often say that “emotions are priced” because although a range of factors influence the price of a stock: its size, value, growth etc. recent research has discovered a very important new factor which measures how exciting or anxiety-generating a stock is. A portfolio of stocks with high EQ (emotional quotient) outperforms one made up of low EQ stocks.
“We can never be rational, however hard we try.”
Why is emotional finance important?
Well, first, there is its semiotic contribution: it gives you the language to talk about things we are all aware of and struggle to express. Unless we understand the key role that our emotions play in everything we do, we are condemned to repeat investing behaviors which reduce our wealth. Emotional finance provides a new insight into how we make decisions that can help us understand better how we may be misled in our search for performance. For example, ultimately we enter into emotional relationships with the stocks we invest in: we love the ones that perform well and hate others. We trust and distrust firms and their management often for quite fanciful reasons. We are driven by our unconscious need for excitement and the belief on one level that we can always have what we want. Whereas, on the other hand, we become anxious that things might go wrong. This conflict between the search for excitement and the associated anxiety of loss has broad implications not just for our own investment decisions, but also generally for fund managers and other professional investors. There is a great wealth of understanding of our unconscious processes and how they drive most of what we do among psychologists and neuroscientists. Were we to draw on this knowledge, and accept the inherent uncertainty of the investment process, we would be able to make better financial decisions. In addition, we would be able to avoid seemingly attractive investment propositions or stocks which are appealing to us emotionally because of the implicit fantasies they offer us. I have in mind, for example, many of the heavily, loss-making unicorns that are currently going to IPOs.
How can we deal with our emotions?
The first thing is to recognize that most of what we do is driven by our emotions both conscious, and more importantly, unconscious. We can never be rational, however hard we try. Being aware of how we feel rather than trying to repress this allows us to manage more effectively what we do and how we do this. Recognizing how we tend to react instead of reflecting is also critical. Investment should be about trust rather than faith, which is even more powerful because it is not based on any evidence and often relates to wishful thinking. If we are able to disentangle our emotional needs, we are able to take a much more considered view. However, the key thing is to recognize the power of our emotions in driving our behavior and stop believing we can ever be rational because we can’t. Awareness is everything.