Rising markets bring optimism and falling markets pessimism and fear, that’s a given.  But along with these market fluctuations comes a side effect to be aware of: emotional investing.  

Emotional investing is just as it sounds –– investment decisions based on emotional reactions, which can cause us to make costly mistakes.  Because when it comes to investing, emotion is not a good thing.

Above is a simple graph that highlights the emotional cycle of investing along with five main causes.

1) Overconfidence.  Emotional investors overestimate their ability to predict the market which leads to excessive risks.

2) Attraction to rising prices.  Emotional investors are attracted/more likely to buy after the price has gone up.

3) Herd mentality. Being part of a group is comfortable; but history has shown us that when the herd moves in one direction, it may be time to consider going in the other.

4) Fear of regret.  Not doing anything simply due to the fear of making the wrong decision.

5) Affinity traps.  Rather than understanding the whys of an investment, we act based on a recommendation by a friend or a mutual tie to an organization.

How to avoid these emotional reactions when it comes to investing? Discipline, an understanding of how markets work, and a good advisor.  For more information on this topic, check out chapter one of The Investment Answer, by Daniel Goldie and Gordon Murray.  Or write to us with your questions, we’d love to hear from you.

Perhaps you’ve read the fascinating articles about Finland and their exceptional education system over the last year or so.  In case you haven’t, here’s the short version: Finland has some of the highest test scores in the world.  And the especially curious part: Finnish schools reject almost all standardized testing before age 16, they discourage homework, and children there don’t start school until the age of seven. Further, the first six years of education are not about academic success, but about being ready to learn and finding your passion.  Private schools don’t exist in Finland; they believe that all children should have exactly the same opportunity to learn, regardless of income or geographic location.

And unlike Americans who love to talk about competition, competition makes Finns uncomfortable.  The Finnish attitude follows the notion that real winners do not compete.

So what does all of this have to do with investing?  The same non-competitive strategy the Finns follow is a winning one when it comes to investing.  Why?  Because when people are competitive, they take a lot of risks.  They let their emotions drive their investment decisions.

A more solid approach is to drop the competitive mindset and focus on the long term.  And index funds are a part of that strategy.  As a long-term investor, owning index funds will benefit you without the added risk.  They’re low cost, diversified, tax efficient, and have a low turnover.  Index investing is being in the game in a smarter way –– without the competition.

For more about the fascinating Finnish approach to education, check out this New York Times article, or one from The Atlantic, or The Week.  And for more on index funds, go here, or email us with questions.  We’d love to hear from you.

Welcome to Money Matters, the official blog of Carlisle Financial Group. Every two weeks we’ll bring you something timely and smart about investing, navigating the markets and strategic financial planning. Whether you have a good understanding of money and investing, or are just getting started, the topics we’ll cover will help to keep you informed, empowered, and moving forward.

Stay tuned for our launch in the coming days. We look forward to seeing you back here!