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The doctor will see you now: how emotional finance can make you a better investor
by David Campbell on Nov 26, 2012 at 00:01
Spend much time in the comment sections of stock trading sites such as Motley Fool and Interactive Investor and one thing rapidly becomes clear: investing for many people is about much more than an attempt to secure riches or a retirement income.
For many, it is closer to a leisure activity, a source of excitement and a game to be played. It supplies excitement, variety, and less pleasantly, a sense of intellectual superiority over others.
These are all sources of pleasure that draw people back to the markets and in at least some cases, cause them to spend a large amount of time online monitoring stop losses and posting snarky comments. Surprisingly, though, little research has been done into the emotional drivers of investment.
Investment management ‘is not therapy,’ says Richard Taffler, professor of finance and accounting at the University of Warwick, and one of the pioneers of emotional finance. ‘But therapy is about giving people a safe environment to explore their unconscious, so it may be therapeutic.’
At this point, many sceptics may be trying to contain their sniggers, but Taffler’s work is underpinned by extensive research, directly interviewing 50 managers with an average of 15 years’ experience and about $500 billion under management, and densely referenced to original psychological research.
Much like behavioural finance, while the concepts used can be nebulous, the lessons are rooted in the practical world of how to be a better investor or fund manager.
‘When we think about markets, the traditional words we use to describe them are fear, greed and hope,’ Taffler says. ‘But investment is not really about fear. It is more about anxiety, and a desire for excitement.
‘The managers we interviewed were certainly not greedy, in the dictionary definition of being rapacious, but they were driven by excitement about the stocks they were attached to. [And] it’s not really about hope, but more about denial, denial that you can’t predict the unpredictable.’
Perhaps one of the biggest insights for investment managers is Taffler’s research into what draws people to markets, drawing on research conducted in Finland, which stores a large amount of anonymous data on its citizens, and the relationship between investment and other forms of sensation seeking.
‘Investment is exciting. What the authors discovered was a direct correlation between driving violations, the level of trades and [stock] turnover.
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