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The Emotionally Intelligent Investor

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Doreen

 

 

 

 

by Guest Columnist Doreen Lima, MBA

 

In the human repertoire of multiple intelligences, an individual’s emotional intelligence quotient (EQ) plays a significant role in crafting a satisfying life. This in part is because a highly developed EQ impacts the effectiveness of people’s minds.

Specifically, EQ is compromised of the following abilities:

  • Knowing your emotions – self awareness – the ability to identify what you are feeling and how it affects your thoughts, behavior & reactions
  • Managing your emotions – self management – the ability to manage your response to situations and circumstances by controlling your impulsive feelings, behaviors & responses
  • Recognizing & identifying emotions in others – social awareness – the ability to ascertain what others are feeling when you are talking to them & utilizing this understanding to relate more easily to others
  • Managing relationships with others – relationship management/social skills – the ability to foster unity, defuse conflict, feel comfortable socially & respond to the emotional cures of others
  • Motivation – the ability to pursue and achieve goals through action, commitment and completion

EQ is now considered to be more important at predicting the quality of our relationships and our ability to succeed than IQ. While it’s true that we are all emotional, the distinction between being emotional and emotional intelligence is that EQ is the capacity to use emotions in ways that solve problems and foster productive relationships.

EQ & Financial Investment

In the financial world, emotional intelligence is a key factor in mitigating the stress, anxiety and uncertainty that surround a variety of problems individuals strive to solve. These might include saving for retirement, home ownership, financing college, defining the amount of risk one can tolerate when constructing a portfolio or deciding how to deal with a rollercoaster stock market and its attendant gains and losses. These are often emotionally charged topics that have can negative effects on mental health, physical wellbeing and personal as well as professional relationships. Becoming emotionally intelligent doesn’t mean that you no longer experience emotions around these types of issues but rather that you learn to manage your emotions in constructive ways. Ways that offer you access to better long-term outcomes because you are better able to remain focused and stay connected to yourself and others. When dealing with financial and investment decisions developing your ability to use emotions to enhance thinking and problem solving is a sound means of coping with the attendant stress and dealing with important financial decisions.

Patterns of Behavior and Investment Decisions

A number of studies have looked at the role EQ plays in investing including one conducted by Professor Michal Stahilevitz at Golden Gate University and Professor Dan Ariely at Duke University where they looked at identifying the role that emotions play in financial and investment decision-making.

Stahilevitz’ and Ariely’s findings provide insight into the psychological patterns of investors. They affirmed that behavior patterns of the less emotionally intelligent investor were employed to avoid fear, shame and guilt. They also discovered that the thought processes of lower EQ investors were less rational than those of an investor with a more highly developed EQ. For example, behaviors such as overtrading, second-guessing positions and frequent hand-wringing interactions with their brokers and financial advisors were all attempts to minimize stress and fear and fell under the heading of “doing something, doing anything was better than doing nothing.”

The potential for making a financial misstep under these circumstances can be financially punitive. When investors operate from a reactive mode rather than an observational or detached one, they can negatively impact both their long and short-term financial goals. If an investor acts out of fear at the wrong time, taking actions such as jumps in and out of the market, the risk might manifest as missing out on gains or defraying losses. As a recent article in Morningstar states, “bad timing costs investors 2% per year” and might be attributed to reactive, irrational investment decisions that are expensive and eat into an investor’s total return.

Banishing Distorted Thinking

Learning to think truthful, non-polarizing, non-distorted thoughts is an important factor in increasing emotional intelligence. Such thoughts can lead to making irrational financial decisions. For example in the Stahilevitz/Ariely study they found that investors were more likely to repurchase a stock if they sold it for a gain or if it decreased in value after they sold it. In these instances the investor associated feeling good with the sales of these stocks. On the other hand, feeling bad was associated with stocks where an investor suffered a loss. In this case, the investor was less likely to repurchase these stocks because they engendered negative feelings.

When we’re dealing with people, looking at past performance makes sense. If someone is known for being late, it’s likely that they will continue to be late whenever you make plans with them. It’s your choice to adjust your schedule or not, accordingly. Applying the same type of historically based thinking to investments is not effective. How a stock performed when you last owned it or sold it is irrelevant. What matters are the fundamentals (e.g. P/E,), current market conditions, sound fiscal policies, innovation, corporate leaders and so on, taken into account at the time you wish to buy or sell the investment. An emotionally intelligent investor does her homework based on what is true and happening in the moment.

Intuition versus Facts

Another example of the importance of realistic thinking is the finding that even when investors do homework before buying a stock, they are less likely to do any homework before selling a stock. Instead they often sell stocks based on gut feelings, rumor or whim. When you buy a lottery ticket based on a “hunch” that you’re going to win, you still only have a 1 in 175 million chance of winning – the same as everyone else’s odds who bought a ticket. As Aaron Abrams, a mathematician at Emory University states, “you’re 100 times more likely to die of a flesh-eating bacteria than you are to win the lottery,” so while selling on a whim might net you a gain it doesn’t necessarily provide you with the best odds of realizing the best possible return. Doing information gathering about the stock and its future potential at the time you propose to sell is as important to do as when you are making a decision to buy. Taking this kind of a rational truth based approach will either statistically corroborate your gut feelings or disprove them altogether, but at least you’re operating from a position based on the best, most current facts available. This is one way to stem “seller’s or buyer’s” remorse.

Luck versus Skill versus Reality

Information and fact gathering and non-distorted thinking are even more significant when you take into account that investors have a tendency to overstate their capabilities or responsibilities as investors. According to Professor Stahilevitz, during bull markets investors often took credit for gains chalking them up to investing savvy as opposed to luck, good financial advice or market conditions. However during a bear market investors were more likely to blame bad luck, bad timing or poor market conditions rather than take responsibility for their role in realizing losses. It’s possible that either of these situations contain some measure of truth but investors that over estimate or under estimate the role they play in putting together an investment portfolio are low on the EQ scale. These types of attributions can lead to rash and sometimes self-sabotaging actions. For example, an investor operating in a bull market who believes he has the Midas touch runs the risk of making over-confident, bold moves that could lead to unnecessary losses.

Warren Buffet, arguably one of the world’s smartest investors, advises that you don’t overthink your investments. His prodigious talent for trading success is based not only on his extra-ordinary talent but also on his access to private information. The average investor does not have access to this same kind of private info nor do they have Mr. Buffet’s investment abilities honed over a period of 50 plus years.

According to John Ameriks of Vanguard, a large sample study of their clients determined that emotionally intelligent investors tended to hold more balanced, slightly more conservative portfolios in terms of asset allocation and they also tended to trade less than investors who did not rate as high on the emotional intelligence scale. This is not to imply that they did better in terms of IRR than an investor with a lesser level of EQ. Studies are currently underway to determine whether this is in fact the case. It does suggest though that their higher EQ levels would have positively impacted the level of stress and anxiety associated with their investment strategies and actions.

Developing EQ & Minimizing Stress

In 2004, Lerner, Small and Loewenstein conducted a study that concluded investors who understand how to use emotions to their benefit have a tendency to put off making investment decisions until they are in a positive mood. This is a powerful way to combine emotions with logic, information gathering, and good counsel in order to achieve a desired outcome that is not dependent on impulse. Most people have heard of the fight or flight response a condition that happens when our bodies receive a jolt of adrenaline in response to a perceived threat. Highly charged emotions such as anger can trigger this same kind of response. It stands to reason that a brain that is flooded with chemicals that cause negative, aggressive reactions and blind us to the possibility of reasoning out a problem is not necessarily a brain that should be influencing or assessing financial data. Understanding that moods are transitory and making a choice to wait for the anger to subside is an excellent way to practice and elevate your EQ.

It’s also a good way to save and deepen the strength of your relationships. Let me give you an example. An investor I know well had been working with a financial advisor for several years. They had established a wonderful rapport built on trust and the ability to interact well together. The advisor was someone of high integrity who went out of her way to serve her clients to best of her ability. One year the investor’s quarterly reports arrived. When the investor read them she was absolutely livid. There was a significant loss reported. It’s not that she wasn’t expecting a loss, it was that seeing the loss on paper made it seem that much more impactful. Her logical self knew the reasons for the loss. They were all legitimate, however her emotional self couldn’t be contained. The investor knew that if she were to speak to her advisor in this elevated state she would likely say things that she didn’t mean and more importantly couldn’t retract. She decided to put off any conversation for at least two weeks. It gave her a chance to cool off and it also allowed her to look at the report from a long-term perspective. When they finally met in person to discuss the report, the investor was able to convey in non-emotional terms her concerns and expectations for the upcoming year. She was also able to tell the advisor of her disappointment in a non-threatening way that showed respect for the advisor’s abilities and acumen. The investor’s portfolio rebounded the following quarter and has continued to perform well. The investor and advisor maintain an excellent working relationship to this day, and often laugh about the dark days of the “black quarter.”

Another lesson to be learned from this investor; she knew that managing her stress over the loss was a very important tactic that would help her handle the situation more effectively. In her case she spent the two weeks adding a more aggressive gym workout to her days.

One of the greatest influencers of stress is the day-to-day news and ups and downs of the markets. Unless you are a trader who depends upon minute-to-minute information you might want to create calm and lessen your anxiety by ignoring your portfolio for short periods of time. If your plan is a long-term one based on goals and a risk tolerance that you’ve successfully conveyed to your financial advisor, understand that you have no insider information and market fluctuations are not controllable by you. Any decisions you make in the short-term as a reaction to these fluctuations might not be good ones.

If you find yourself experiencing high moments of stress during times of market volatility try to pinpoint how it affects you physically. Do you harden your jaw? Does your chest tighten? Do you make fists with your hands? Does your stomach get upset? These are signs that you cannot afford to ignore. When these stressor signals appear, bring practices such as breathing to release muscle contractions or do something to change the picture like the “black quarter” investor such as getting up and going for a walk. If you understand that physical symptoms are the gateway to building emotional awareness you’ll be better at managing your emotions constructively and entering into important negotiations from a position of clarity and reasonableness. For example, knowing that every time you make a fist is a signal that you are angry provides you with choices for action based on reasoned response versus blind reaction. Your choices, now that you recognize this emotional signal, are to find a way to release the anger or to transform it. To release it you could go to the gym. To transform it you could watch a comedy. Either type of action allows you to revisit, at a later date, a discussion or situation that requires higher level thought processes with a clear and open mind.

One caveat; stressed out investors tend to lose out on valuable sleep. As many studies have shown sleep is transformative. We form memories during sleep, our immune system is given some well-needed rest and other restorative bodily functions take place. An investor who is stressed can experience compromised states of mental and physical health, which again in turn can lead to poor decision-making. Find ways to ensure you get a good night’s sleep.

Consult a physician if need be or a sleep specialist. Put away phones, tablets and computers at least half an hour before you retire for the night. Keep a pad by your bed to write down any last minute to do’s for the next day so you can get them off your mind. Wear a sleep mask or keep a very darkened room. These are just a few of the actions you can take to stack the sleep deck in your favor.

Rational Investing

Whatever investment decisions you choose to make – doing so based on prudent fact gathering, conversations with a trusted and qualified financial professional, an understanding of your patterns of behavior and your tolerance for risk are all part of an emotionally intelligent realistic approach to investing. If you are someone who is daunted by risk discuss this thoroughly with your financial advisor. Don’t invest money that you need for your immediate concerns because investment decisions are often long-term plays. Remember that clear lines of communication at the beginning of your relationship with a financial advisor are very important. If you are not a clear communicator consider taking a course. Ask thorough questions and learn how to make clear requests so that there is no chance of confusion when the time comes to make changes to the portfolio of if there is a change in your status. Remember that developing your level of EQ will be an ongoing lifelong practice.

 

 

Doreen Lima is a certified Emotional Intelligence Coach, trained Mediator and Media Training professional. She helps people become confident communicators who relate successfully with others. Her clients develop skills to increase their sphere of influence, strengthen relationships, become more effective leaders, and learn to minimize the stress of social interaction. You can contact Doreen at hello@doreenlima.com