06 January 2022

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Emotional investments

Author: Luigi Campopiano

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According to behavioral finance experts at Oxford Risk, the current environment has created a situation in which the risk of emotional investments has reached a new peak. When investors are guided by their bellies, it is estimated that these choices cost them 3% per year in terms of lost returns over the long term, but this percentage may be higher in the current crisis.

Emotional investments concern people who act on their behavioral impulses and make investments on the wave of emotion associated with times of growth and decline in the markets. This often leads people to buy when the markets are up and sell when they are down, under the pressure of a huge amount of "noise" around such investment opportunities. Investors often pursue investments they hear about more often because, in a stressful time, they feel emotionally comfortable investing in what they hear about regularly, which promises short-term returns.

The current situation, therefore, represents a perfect storm for emotional investments. After the collapse due to the coronavirus recorded in the first quarter of last year (when the stock markets saw huge drops), there was a generalized rise everywhere (with the markets of all over the world on the rise). The optimism is greater in light of the hopes linked to the distribution of the Covid vaccine and the economic and fiscal incentive programs. However, huge economic problems are expected due to unemployment and huge public deficits, so we must expect the unexpected in the markets in the coming months.

Furthermore, the increase in the value of Bitcoin has pushed several unwary investors to the gold rush. Many have thrown themselves headlong into this asset class which by its nature has strong volatility and has already at other times caused the less accustomed to the mechanism of finance to lose considerable sums. Unfortunately, the pandemic has led many investors to act on the wave of emotion and thus reduce their time horizon: all this has increased the appeal to risky investments that promise high returns in a very short time.

Acting without firm guidance from a consultant or having an excellent knowledge of the world of finance leads to negative effects on assets. According to Oxford Risk experts, the cost of the "behavioral gap" (losses due to hasty and important investments in positive periods for the markets and a reduction of the same in periods of decline over time) will be around an average of -1.5 % and a -2%.