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By Alanna Petroff | 05-02-2012 01:00 PM

Emotional Traps Hamper Investors

Accepting that you are not a disciplined robot is an important step to overcoming behavioral obstacles, says M&G's Dave Fishwick.

Alanna Petroff: We're always trying to buy low and sell high, but sometimes emotions can get the best of us and we all make a few mistakes. That was the topic of Dave Fishwick's talk when he spoke at Morningstar's 2012 Investment Conference. Dave is head of macro and equities investment at M&G and he spoke to me one-on-one about the certain emotional traps that we all make when we're investing. Here's what he had to say.

David Fishwick: I think one of the most obvious emotional traps is extrapolation of recent experience. So, in terms of thinking about payoffs in investment markets, we're hugely influenced by what's just happened to us, and we like being involved in good things, we don't like bad things. So emotionally, we're drawn to things that have good news stories about them that have felt good. Investing in things that have felt bad and has been a negative experience is a difficult thing to do.

I think doubly you can take the view that where your emotions are also influenced by other people, because we are social animals, and we’re not the logical robots that sometimes we want to pretend we are. We're hugely influenced by what other people say to us. We're hugely influenced by what other people tell us they're doing, and we feel a very strong need to want to join in. And that's a very, very dangerous thing to be doing if it is not a considered, well thought-out, independent conclusion that you've drawn yourself.

Petroff: So, those are two specific emotional traps that investors have when they are investing or are currently invested. And how do you deal with those emotional traps? How do you try to stay rational when you're making investing decisions?

Fishwick: The first thing to do is not to expect to be the disciplined robot that you would like to be. So, there's an aspect in which embracing this is very, very important. So understanding your own motivations, understanding why you're going to feel like you do. Again, in investment, not a lot of people talk about how you feel about things, but actually it is a very, very important thing to us. So, understanding why you're going to be reluctant to do things, understanding why you're going to be drawn, and learning to kind of cope with that I think is important.

The other thing that you can do, I think, is to use an imposed source of discipline in a quantitatively motivated valuation framework that forces you to confront the reality of sustainable returns rather than what's just been exciting and interesting, and helps you have the discipline that emotionally you're not going to be able to maintain.

So, in a sense, it flips the burden for you. It says, give me reasons why you are not going to do X, because these indicators suggest you should, rather than starting from, what do I feel like doing, because if you do that, you could end up gyrating around with the emotions of the market.

Petroff: Okay. That sounds good. Are there any other kinds of quick tips for investors that you think that they should be aware of?

Fishwick: I think being honest about what is plausible to know and learning to cope with uncertainty in general, and not expect to always and everywhere be right about things and know all the answers. And I think also understanding that it is the case that other people struggle with this as well. So, it's not just us as individuals but actually it's a broader human observation that although we're drawn to the notion that there are experts and people must know the answer, the actual factual reality is, it's very, very difficult for people to know everything about everything all the time. Jjust to understand that and be comfortable with it I think is very important.

Petroff: That was Dave Fishwick. He is head of macro and equities investments at M&G.

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