The financial market, just like in life and like a roller coaster, is full of exciting rises, dizzying falls, and unexpected turns that challenge our peace of mind. Investing is not just a matter of numbers or statistics or strategies. It is also an emotional journey that confronts us with our fears, ambitions and deepest beliefs about money.
And this being the case, the idea of this note is to explore those emotions and see what are the practical aspects that a person, who needs to make a decision, should take into account to avoid unwanted surprises.
The primary concept that reigns unquestionably behind a financial investment is that, if we expect to receive a return above the capital we invested, it is because we are assuming that we are going to take a risk. The flip side of the potential reward that an investment offers is risk. Necessarily. And the most important secret to gaining confidence in what we do is to properly understand the magnitude of the risk we are taking and whether that risk is appropriate for our profile.
It is not my intention to belittle my readers, but let me express out loud that if they offer us a rate of return above market parameters, all the alerts should ring for whoever is receiving that proposal. And if not let’s look what happened to the inhabitants of San Pedro. A third of the population fell into that scam where the promise of return was 1% daily in dollars. We must know that returns of that magnitude in practice They do NOT exist. It is enough to think for two minutes, comparing with reasonable parameters. For example: US inflation is 2% annuallya 10-year bond pays a rate of 4.65% per year. What kind of risk would pay an annual rate of 3,678.34%? That is the equivalent value of a 1% daily rate compounded annually.
And how do you explain why people fall for these deceptions?
Emotions cloud reason in many cases. Investments implicitly promise the possibility of achieving our objectives. But they also expose us to a torrent of emotions that, if not managed properly, can cloud our reason.
And the lack of financial education ends up creating a lethal cocktail. I don’t want to expand on this point, but the statistics for Latin America in general and Argentina in particular, are conclusive in this regard. Less than 30% of the population understands the most basic financial concepts. There is pending work in this regard.
The emotional connection with money
Money represents more than numbers in a bank account. It is synonymous with security, freedom and the ability to build a future. Therefore, our financial decisions are often loaded with emotions. When we invest, we not only put our capital at stake, but also our expectations, dreams and fears.
This emotional connection is what makes the financial market so fascinating and, at the same time, so challenging. Each swing in the markets can be perceived as a threat or an opportunity, generating emotions ranging from euphoria to panic.
The most frequent emotions that people express when faced with financial decisions are:
- Fear: It is the most intense emotion and, possibly, the most dangerous. It arises during abrupt market declines or economic crises. Fear can lead to hasty decisions, such as selling at the most unfavorable moment to “avoid further losses.” Paradoxically, these decisions often amplify the negative impact instead of protecting us.
- Greed: During bull markets, the potential for quick profits can fuel risky behavior. Many investors are tempted to chase overvalued assets or take disproportionate risks, believing that the profits will be unlimited.
- Euphoria: Periods of prosperity generate excessive optimism. Investors can feel invincible, forgetting that markets are cyclical and that every boom has its bust.
- Repentance: Nothing is more frustrating than looking back and regretting not making a different decision. Whether it’s selling too soon or failing to act when an opportunity presented itself, regret can paralyze future decisions. And in my experience, if the decision was made consciously and with the best information available at the time, the person should not question it.
Lastly, emotions are linked to cognitive biases that affect our perception and judgment:
- He confirmation biasIt leads us to search for information that supports our beliefs, ignoring warning signs.
- He overconfidenceIt can cause us to underestimate risks or overestimate our abilities.
How should we analyze an investment proposal and what are the essential aspects?
Knowing our investor profile is key. When we ask a person what range of returns they expect to obtain from their investment, in many cases they mark the highest range and continuing with the inverter test, When asked about risk tolerance, the same investor answers that it is low, which is a contradiction.
To obtain higher returns you must be willing to tolerate a wider range of volatility, that is, price variation. Since what determines our risk tolerance is how much we can tolerate the value of our investment falling. And there is no single or correct answer here. ANDit depends on each person. And I think that the individual response is related to being able to sleep well despite the decline in the portfolio, understanding that market fluctuations are normal and that time is in our favor.
He TIME It is a fundamental variable. How long do we have to wait for the investment to be recovered? If we need to have money in a short horizon, less than a year, for example, we should not take high risks because if that risk materializes, we will be forced to sell our assets at a price affected by the circumstances.
But this is not all. There is one more aspect to consider. Time can compensate for a fall generated by circumstantial events. What time cannot mitigate or remedy is the credit risk of the asset. If we buy a bond from a company that has lost its repayment capacity or invest in shares of a company whose business is in check, it is not a matter of waiting. There it is a question of seeing how much I can recover by selling the asset.
Therefore, I perfectly understand that all this analysis for those who do not have an affinity with the world of finance can be overwhelming. That is precisely why they exist financial advisors. To accompany those who have a surplus and want to make their money work. And here, at this point it is relevant to check that the person providing advice is an accredited professional registered with the National Securities Commission, which is the body that regulates the capital market and its participants. And have experience in providing this advice. A friend can share his experience with us, but the point is that his investor profile may be very different and what is not a problem for him, may be a problem for us.
Conclusion:
Investing is not just a technical act, it is an emotional exercise. Understanding and managing our emotions is as important as analyzing graphs or reading financial reports.
In the end, true success in the market does not depend solely on numbers, but on our ability to maintain calm and perspective in the midst of uncertainty.
Source: Ambito
