The Emotional Investor (Part 4)

Do you have to be brain-damaged to win at investing?

Source: FXCM

Sometimes it seems that way. A researcher wanted to study the effect emotions on investors. So he gave a group of normal and brain-damaged participants each $20 and asked them to choose whether or not to bet on a coin toss 20 successive times. If they lost, they lost a dollar; if they won, they won $2.50.

Rationally, everyone should bet every time. The risk is 50-50, the expected return from each toss is $1.25. Odds are they’ll end with $25. But it didn’t work out that way. Normal subjects invested only half the time, earning $22.80. Brain-damaged participants bet most of the time and had an average of $25.70 by the end.

The main reason normal folks did so poorly was how they reacted to losing. Instead of seeing each toss as independent, they sat out 60% of the time after a losing toss. Fear of successive losses kept them from making rational decisions.

Edvard Munch, The Scream. Source: Wikipedia

That’s the way investors behave, too. The market’s a lot like the coin-toss game, except stocks go up three quarters of the time. But after the dot-com bust and financial crisis, people swore off stocks, even though the following years were great times to be invested.

Don’t doubt in the dark what’s clear in the light. Our emotions may help us get through life, but when we’re investing, they can be our worst enemy.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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By |2017-07-17T12:23:00+00:00March 19th, 2015|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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