160. Beware of your emotions and moods (10. Building Finance Intuition)
“Whatever is begun in anger, ends in shame.” — Benjamin Franklin
In 2007, I joined Lehman Brothers as India head of Interest Rates Derivatives Technology teams. That was my first foray into employment with a global financial institution and the title of “Vice President” felt fancy. I was buoyed by a sense of excitement and optimism about my career prospects. Once I joined Lehman, although things seemed upbeat on the surface, I could not escape a subtle sense of unease. Something seemed off. Within a year of my joining Lehman Brothers, it went bankrupt. I found myself in a very nebulous financial situation. The future felt very uncertain suddenly. The excitement of a fancy title (once I joined the bank I realized that the title meant nothing special) and employment with a preeminent organization blinded me from doing even basic enquiries on the health of global finance industry.
“I don’t want to be at the mercy of my emotions. I want to use them, to enjoy them, and to dominate them.” ― Oscar Wilde
Our moods and emotional disposition have disproportional impact on our decisions. When we are optimistic, we tend to be more risk taking. When we are pessimistic, we tend to become more risk averse.
When things are going well for us, we tend to overestimate our ability and be more confident of our future. This loosens our risk temperament and we end up making riskier decisions. If someone known to us made good returns on a speculative instrument (say, a crypto currency), we tend to become more amenable to speculate in that product as well. Even in the face of envy, we tend to be more risk taking.
When we are sick, we tend to get pessimistic. When under the weather, we find it harder to believe that stocks may do well in the future. We will be lot more comfortable putting money in steadier products like money deposits and be wary of investing in volatile instruments.
When we successfully complete a full marathon or lose 10Kg weight or accomplish something spectacular like that, we tend to feel that we can conquer anything — we may be willing to buck our natural tendencies and invest in riskier and volatile products.
When we are short of sleep, we tend to be less opportunistic. We may reject good investment ideas and accept usurious products, as we may want to avoid cognitive load of any effortful due diligence process.
“Only when you combine sound intellect with emotional discipline do you get rational behavior.” — Warren Buffett
Morningstar India discovered that the three-year return of a thematic mutual fund as of April 2022 stood at 23% but the average return for investors in that fund was a good 6% lower. Morningstar also observed that the best-performing equity fund delivered 40% over the same three-year period, however an average investor in this fund made only 20% return. Many studies of this kind have been done and it was found that the average investor lags the fund performance over medium to long term.
How come an investment product gave a higher return than an average investor in it? This is because average investor is moody and emotional. An average investor may have redeemed investment when an expert on TV mentions that assets may be peaking in their values — so, in effect, in fear that he or she may lose out on the gains already made. Some investors may have invested at or near peak out of fear (and a bit of envy perhaps) that he or she may be missing out on the gains made by their acquaintances who happen to be investing in that fund. Similarly, investors may have redeemed when prices fell because they may have been scared of how much further the prices may go down. For various emotional reasons, investors would have waded in and out of the fund at various points in time and thereby realizing a return different from the fund’s performance and that too generally materially lower.
“The emotions of man are stirred more quickly than man’s intelligence.” — Oscar Wilde
When we feel anxious, fearful or depressed about something, it can influence our view of all things at that moment, irrespective of if that thing is significant or not. Stress turns off our long-term systems — both physiological such as digestion, growth, immunity, reproduction etc and psychological such as decision-making involving short term trade-offs for long term benefits. Because of this, we tend to make shoddy decisions when we are under stress.
We feel compelled to take action when faced with stress even in situations when taking no action is better. Stock prices drop and cell phones go on sale all the time. As they happen, we fail to realize that these reflect the normal ebbs and flows of economic life. We tend to unnecessarily react to them — like buy stuff just because they are on sale.
Bottomline
“Jonathan Haidt said in another context, “The emotional tail wags the rational dog.” ― Daniel Kahneman
We find it difficult to respond sensibly when faced with any of our basic emotions such as fear, greed, envy, disgust, surprise or joy. Our unconscious-self kicks in with a response well before the conscious brain even becomes cognizant of the situation. In the throes of these emotions, we tend to make decisions that compromise our long-term goals — like selling stocks during stock market corrections or quitting jobs impulsively because we can’t take our bosses anymore. We are essentially emotional and hardly rational. Evolution may have developed our emotions as reliable guides in making right decisions in the natural world but we find ourselves tripped up by these same emotions in the human world of money and careers. It is hardly surprising that unmanaged emotions are among the biggest impediments in our wealth creation journey.
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