Emotions can adversely influence our investment decisions and lead to irrational behaviour, according to a new study by Franklin Templeton Investments.
Many a time, one's emotional response is so instantaneous that one is unaware it is even occurring. And experts say a small little part of our brain called the amygdala may play a key role in our bad decisions.
It functions as the brain's early warning system, sending out messages of fear and anxiety to raise the alert of imminent trouble. This may cause us to regard negativity and pessimism as accurate.
Understanding our emotional state and putting plans in place before emotions take over can help prevent poor investment decisions. The Franklin Templeton Investments report found five common mistakes made by investors, which can be easily avoided:
This refers to the deep pain investors feel upon taking a loss and the lengths to which they will go to avoid that pain.
A study by psychologists Daniel Kahneman and Amos Tversky found that between a certain loss of US$3,000 (S$3,675), and an 80 per cent chance of losing US$4,000 and 20 per cent chance of losing nothing, more than 90 per cent of investors polled picked the latter, even though statistically it was the riskier proposition.
Since the global financial crisis- led market meltdown in 2008, many investors have been reluctant to buy equities out of loss aversion. They have preferred to remain in low-yielding vehicles that may deliver a negative real return after inflation.