The emotion and psychology in investing

Psychology and emotions play a very important role when it comes to investing. In fact, some claim that stock market investment is 90% psychology and 10% knowledge. When money is involved, humans often become irrational, and even more so when it's our own money. That is to say, we stop reasoning and act on impulses. Let's see it with an example:

• When someone loses a significant amount of money in an investment, they will probably invest less the next time.
• If you bet on something and win, it is likely that next time you will bet less cautiously because you feel that the money won in the previous bet is not yet yours.

In the decision-making process, two factors come into play:

• Analytical capacity, which is the ability to evaluate and understand the context in which a decision is made and its possible repercussions.
• Emotions, which are the psychological states of the person making the decision.

Even if you have your investments carefully planned thanks to analytical capacity, if you let emotions control you, it will be difficult to stick to the plan. Therefore, if we want to invest and achieve good results, it is essential to learn to control our feelings. But what emotions usually arise when investing?

• Fear leads to bad decisions. Many people are afraid of losing money and only invest in very safe products with low profitability. It is paradoxical: out of fear of losing money, money is lost. Many people do not make their money profitable simply out of fear, due to lack of knowledge.
• Greed drives us to try to win more and more. The temptation to achieve high returns in a short time leads to bad decisions with disastrous consequences.
• Euphoria, understood as an excess of positivity, leads us to lower our guard. As a result, wrong decisions are made without paying much attention to details.
• Sadness, although it may seem unrelated, also plays an important role. When someone feels sad, they try to improve their mood by indulging themselves, so an investor can make a very bad decision just to indulge themselves to feel better.
• Envy towards those who achieve high returns in a short time usually leads to mismanaging money.

These emotions intensify especially when investing in high-risk products, especially when deadlines are shortened. To avoid these emotions, it is important to make good planning and stick to it. Another good option is to automate. You can set up periodic transfers to your investment platform to avoid spending the money you had planned to invest on unnecessary things.

When making financial decisions, financial education is fundamental from an early age and throughout life. In the investment process, up to 128 cognitive biases that lead to mistakes come into play, so it is important for each investor to identify those that affect them the most to avoid them. The biases that most affect Spanish investors are overconfidence and risk aversion. Adequate training combined with experience is essential to mitigate these biases, but perhaps these guidelines may help you:

• Examine investment alternatives: there is currently a wide variety to choose from. If you are not familiar with alternative financing, we recommend taking a look at the blog article explaining Crowdfunding Platforms (PFP). At Inversa, we specialize in crowdfactoring, financing short-term invoices. To better understand how it works, you can take a look at this other blog article explaining the basics.
• Consider the pros and cons of different options.
• Think the opposite: list a series of reasons why the initial decision could fail.
• Resort to the classic five Ws of journalism: what you want to invest in, why, how, how much, when, and for how long.
• Follow a checklist. The CNMV proposes the following:
  • Have I carefully read all the product information?
  • Is the information complete?
  • Do I understand the basic characteristics of the product?
  • Do I know what I am investing in?
  • Do I know the risks?
  • Does the product fit my investor profile?
  • Is the investment time horizon consistent with my investor profile?

We hope that with this article you will be more aware of the role emotions play when investing, in order to learn to manage them better and achieve better results in your investments.