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How not to be your own worst enemy in the markets

Lisa Kramer, a professor of finance at Rotman School of Management, University of Toronto

Chris Young/The Globe and Mail

Acting on gut feeling has made a few millionaires, but it has drained a lot of nest eggs, too. "We're human, and emotions are part and parcel of being human," says Lisa Kramer.

A University of Toronto professor with a specialty in behavioural finance, Prof. Kramer studies the way emotions affect financial decisions. The key for investors, she says, is to be aware of their inevitability and keep them from interfering.

"It's not about trying not to be human," Prof. Kramer says, "but rather immunizing our financial portfolios from the impact of those emotions."

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How can feelings be held at bay? We asked three financial experts about the emotions that can lead to poor choices – and the ones that can lead to sober second thought.

Pride

Everyone wants to be exceptional, Prof. Kramer says, "so there's this pressure to beat the market. We all want to feel that we're better than average, but there's no shame in being average."

The pressure of pride has a tendency to distract investors from the rational end of a stock rally, says Meir Statman, a professor of finance at California's Santa Clara University and author of What Investors Really Want.

"If you made the right choice to buy a stock, and you think you're a genius," and keep trading blindly, he says, "eventually you end up losing like gamblers in a casino."

Fear and hope

Nearly half of Canadian investors surveyed in a 2015 Bank of Montreal InvestorLine study said they fear financial loss when making investment decisions.

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"But 93 per cent of your return is going to be based on proper asset allocation," says Larry Moser, divisional manager for BMO InvestorLine in Ottawa. "The key is to diversify and pick the right types of investments. Seek out financial advice from experts and do your research."

In 2008 and 2009, fear drove many people out of the stock market, and often they held their money in cash or other asset classes in fear of a further drop.

"Pride and regret prevented them from getting back into the market," Prof. Statman says. If fearful investors wait too long, and the market begins rising, they will buy back in at higher prices than they sold at, and "they'll feel like idiots."

In the same universe is hope, "a very useful emotion. It moves us forward. But you can have unrealistic hope," Prof. Statman says. Like fear, it has to be tempered with reason.

He likens this to buying lottery tickets. You can't pin your whole livelihood on one chance. Diversifying you hope – and your portfolio – is wiser. Like with the lottery: "If you spend a dollar a week, it's no big deal, but if you spend half your pay on it, it's an exaggerated hope."

Sadness and depression

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Prof. Kramer's work at the University of Toronto often focuses on depression and seasonal affective disorder, the negative moods felt by some people as the days shorten. In autumn, "we're biologically wired to become more despondent and more conservative in our decisions," she says.

People become more averse to financial risk, she says, and "we just don't feel super excited about holding stocks, for instance. I think this is actually linked to a lot of volatility we see in markets in the fall."

But, she continues, "we can't just all of a sudden be like that. ... Markets are going to go up and down."

She suggests developing a plan that includes not checking the stock market every day or every month.

Anxiety

It affects 97 per cent of Canadian investors, according to the BMO's psychology-of-investing study. "Everybody feels anxious when making investment decisions," Mr. Moser says. "They feel a lot of pressure making decisions they might not feel entirely comfortable about. ... We have a lot of clients who are doctors – experts in the medical field, but not investing. Why shouldn't they be anxious about investing?

"The key is to breathe deeply, do your research, so you don't make any rash decisions," he says.

Sadness (again) and disgust

Sometimes negative emotions can build character and understanding. Disgust, Prof. Statman says, makes it easier to ditch once-loved stocks that dropped in price.

And sadness? "That says, 'Let me sit tight and think, and cry a bit – and not act in haste."

He compares the sadness that comes with a bad pick to being turned down for a job. Maybe, with some time and thought, you realize that it wasn't the one for you. "'Maybe I should rethink and apply for a different kind of job,'" he posits.

But sadness can also spur investors to rash actions, buying and selling when you shouldn't.

"People who are sad go on shopping sprees because they want to change how they feel. But if you are sad, and buy a bunch of stuff for thousands of dollars only to wake up the following morning and think, 'What have I done?', that's not the very best action."

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