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Emotions can negatively affect financial decisions

Posted Jun 09 2009 12:16pm

Heart The field of behavioral finance seeks to explain the set of psychological biases that affect people's investment decisions.  If you couldn't bring yourself to sell a loser stock, or if you have picked investments because they felt "safe," there's a good chance you're managing your money with your heart and not your head.

So what are these emotion-based behaviors that hurt our investing performance?

One of the more common examples is a so-called " anchoring" bias.  Everyone develops attachments that can be irrational sometimes, whether to a house, a car, even a person.  People can also get overly attached to a particular investment, believing it will reach--or return to--a certain price.

Another type of bias can cause an investor to ignore realities and do nothing--believing that "I can't sell now.  Look how much I have lost!"  This "loss aversion" bias has become more common due to the market turmoil, behavioral-finance experts say.  Because losses hurt so much, investors tell themselves it's not a loss until they sell.  Unfortunately, this investor could end up seeing that stock investment continue to drop.

Boomer money Investors with an " overconfidence" bias often trade too much and manage their portfolio on a stock-by-stock basis--while assuming they can beat the market, which probably won't happen.

Observers agree it can be difficult for people to recognize the different types of biases in themselves, and even more difficult to overcome them.  However, while many of these biases exist, investors and financial advisers can work to lessen some of their effects.  Stepping away from the situation before you make a quick investment decision also can help.

Source: The Wall Street Journal, June 8, 2009  

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