Should you avoid making emotional investment decisions?
Acting emotionally when it comes to your investment decisions is a difficult thing to avoid. Fear and greed are two emotions that drive us to make poor investment choices. Fear of losing money or of being wrong is two of many reasons why mistakes are made. In today’s article, we look at five of the main emotional investment decisions people often make and why you should avoid them.
Greed plays its part too. While many of us are aware that the best way to invest is to think long term, many will get caught out when markets perform well or badly in the short term.
What you will learn
- How fear and greed influence emotional investment decisions
- The dangers of panic selling during a market crash
- Why chasing returns after a rally can be a costly mistake
- The risks of trying to time the market versus staying invested
- How overconfidence and anchoring can harm long-term returns
Let’s explore five common emotional investment mistakes that can seriously derail your long-term goals.
Each section highlights what happens, why it’s a problem, real-world examples, and the key lessons to help you avoid falling into the same traps.
1: Panic selling during a crash
This has to be one of the worst but most common investor mistakes. Bad news sells, so when markets fall, you’ll see headlines like “Billions wiped off worldwide markets as investors panic-sell! “You check your portfolio and sure enough, it’s down 10%. Heartbreaking.
The following day, it’s dropped even further, and you’re now worried that if this trend continues, your retirement plans could be in tatters. So, you cut your losses and transfer all your stocks into cash with the intention of reinvesting when things “get back to normal”.
Example: The stock market crashed in March 2020 during the COVID-19 pandemic. Within weeks, the markets had rebounded dramatically, and those who had sold missed the recovery, typically getting back in after the event, missing gains.
Lesson: Emotional decisions based on fear often lead to selling low and missing gains.
Related reading: Investment considerations during a market downturn
2: Fear of missing out after a rally
Past fund performance statistics after a market rally are often exaggerated and misinterpreted, in that they may appear staggeringly good. Investors rush into these funds or stocks when these performance stats are published, thereby buying at the top. These stocks sometimes carry momentum and may continue to perform before running out of steam.
Typically, investors end up disappointed when prices correct, ending up with losses. The statement “past performance is no indication of future returns” is a serious one.
Example: In 2021, following a strong tech rally, many investors rushed into high-flying stocks like Tesla and crypto at all-time highs. Prices were later corrected, leaving many investors with losses.
Lesson: Buying based on hype or fear of missing out often results in overpaying.
3: Trying to time the market
One of the most common questions we get from investors is, “Is it a good time to invest?” Well, the answer is that several years ago was the best time to invest. The second-best time is now.
So, the answer is always yes! Many would say that trying to time the market is a fool’s game. Is it best to invest after a rally when performance statistics are great? Or after a crash, when performance statistics are poor? There’s no correct answer, but to simply invest and think long term for the best results.
Example: Investors who pulled out during the 2008 crash and waited until 2013 to reinvest missed a huge portion of the recovery. Their long-term returns were significantly lower than if they’d stayed invested.
Lesson: Emotion-driven attempts to time the market usually lead to poor results.
Related reading: Time in the market vs. timing the market
4: Overconfidence after a winning streak
After years of strong returns, investors sometimes pile into the same tried and tested stocks or funds, hoping for more of the same. They forget to diversify, thereby ending up with poorly diversified and higher-risk portfolios than they originally intended. This can lead to poor results and poor performance.
Example: After several years of strong returns, some investors increase risk by ditching diversification to chase returns.
Lesson: When volatility returns, concentrated portfolios fall harder. Overconfidence can lead to riskier decisions at exactly the wrong time.
5: Anchoring to past prices
Anchoring is a powerful psychological bias where we fixate on a specific number, often the price we paid for an investment. This emotional attachment can cloud our judgment, leading us to hold onto underperforming assets in the hope they’ll recover, even when better opportunities are available.
Understanding this behaviour can help you make more rational investment decisions and avoid costly mistakes.
Example: An investor buys a stock for £50, and it drops to £30. They refuse to sell or reassess until it gets back to £50.
Lesson: They hold poor investments for too long or miss better opportunities. Lesson: Emotional attachment to past prices can distort future decisions.
Factors to consider
- Are your investment decisions influenced by emotion or logic?
- Do you have a long-term plan in place to reduce reactive behaviour?
- Are you diversifying your portfolio or chasing past winners?
- Do you know when to reassess an underperforming investment?
- Are you holding onto poor investments just to “get back to even”?
Frequently asked questions
Keen to learn more about avoiding emotional investment decisions? Read our selection of FAQs.
What is emotional investing, and why is it risky?
Emotional investing happens when decisions are driven by fear, greed, or impulse rather than logic and planning. It often leads to panic selling, chasing trends, or holding onto poor investments, all of which can damage long-term returns and derail your financial goals.
How do emotions affect investment decisions?
Emotions like fear and greed can cause investors to sell during downturns or buy into hype during rallies. These reactions often lead to buying high and selling low, the opposite of successful investing. Staying rational and focused on your long-term plan helps reduce emotional decision-making.
Why is panic selling a mistake?
Selling during a market crash locks in losses and often means missing the recovery. Markets are volatile in the short term, but historically rebound. Investors who panic-sell typically re-enter after prices rise again, losing out on gains and harming their long-term performance.
Can you ever successfully time the market?
Timing the market consistently is nearly impossible, even for professionals. Missing just a few of the best-performing days can significantly impact returns. A better approach is to stay invested and focus on time in the market rather than trying to guess the perfect moment.
How can I avoid emotional investing mistakes?
Stick to a long-term investment plan, diversify your portfolio, and regularly review your goals. Avoid reacting to headlines or short-term noise. Working with a financial adviser can also help keep your decisions grounded in logic rather than emotion.
