What is emotional investing and why does it do so much harm?

Emotional investing is when investors make decisions out of fear or greed, rather than developing and sticking with a long-term plan.  When the stock market drops, fear investing leads people to sell at low prices and miss the recovery. Greed investing causes people to increase risk when markets are strong, and the higher risk then later magnifies the fear investing when markets fall. Brain science helps explain fear investing. When feeling fear, the brain relies more heavily on the smallest and oldest evolutionary part of the brain, which is responsible for fight or flight.  Fight or flight is a valuable survival response that may save your life regularly from physical danger (e.g. when a car crosses a red light and you are a pedestrian jumping out of the way), but is not effective for making long-term decisions, such as financial decisions.  Studies indicate that investors who make emotional decisions end up with lower returns, to the tune of 4% per year over 20 years (Dalbar Inc., and other similar studies). Someone who started with $100,000 and was not an emotional investor could end up with $360,000 more than the emotional investor over 20 years. Watch the WealthStep Financial Independence video to improve your financial literacy and learn how to reduce or avoid emotional investing, and why market volatility is a risk you should at least partly embrace because it has a long-term reward, whereas inflation, longevity and emotional investing are worse risks that don’t have rewards. Choose your risks wisely.