When I was growing up, my father taught me the value of saving by encouraging me to “invest” my money in a savings account that he managed for me. When I started working summer jobs and opened my own bank account, I realized there were big differences between my dad’s “interest rate,” and what the banks were paying. When I asked him about it, he taught me about the potential of making better returns by participating in the growth of companies through stocks. I opened an online brokerage account and started looking for my first stock purchase.
At the time, I had a Motorola phone that I loved. I knew firsthand that the company was making great products, and all the buzz suggested it was on the ascent. I was an inexperienced investor, but Motorola felt like a company primed for growth. So I invested, and it paid off—at least initially. I wasn’t the only one who liked my Motorola phone, pushing the stock price in my favor.
My approach worked. I sold my stock while Motorola was at a high and made money on my investment, but the experience made me want to put more science behind my decisions. I wanted to learn how to replicate the win and make sure I recognized trends—like the arrival of smartphones—to avoid being burned.
Effective investing requires a combination of cognitive and emotional awareness. We can’t run on our guts entirely, but we can’t ignore them, either.
How enthusiasm alone drives markets
We know that public markets aren’t always rational, and not every investor is in it for the long haul. The question is whether that’s really a problem. We also know that some investors are willing to hedge their bets on “riskier” opportunities for potential future growth, while others want to invest in a proven track record. A healthy market requires both buyers and sellers to have different risk appetites and make different bets.
One study showed that when investors are excited about a new product announcement, it leads to higher-than-expected stock returns. Conversely, investors who back high-profile opportunities can be let down by disappointing earnings that don’t match projected valuations. These eager investors may be driven by enthusiasm alone, but the market is healthier as a result. We know from recent investment activity that a generally bullish overall sentiment is driving billions in new investments.
Some may call this recent enthusiasm irrational exuberance, but it’s not a new or recent phenomenon. I felt that same intuitive thrill when I invested in an electronic signature company and a location-based dating app. Both companies were eventually bested by DocuSign and Tinder, respectively, but that only confirms that my gut was leading me in the right direction. The challenge for investors is to use the gut to point the way and the mind to pick the best bet.
Investing with emotion and intellect
Coordinating gut feelings with rational evaluations is one of the hardest things about being human, let alone investing. Through my initial experience with Motorola and years spent working in the industry since, I’ve learned it takes a conscious effort to balance head and hunch, along with reputable financial resources and professional consultation. Here’s how:
1. Evaluate the market opportunity.
If your gut is drawn to an investment based on your personal interests or pain points, it’s fair to assume others will feel the same way—but good investments aren’t made on assumptions. It’s important to determine the market opportunity. What demographics are in need of this solution? How likely are they to recognize that and purchase this offering? How competitive is the space? Determining whether an investment opportunity is right for you—and then right for the market in which it needs to thrive—is the work of both emotion and intellect.
2. Look into the management team.
Sussing out the health of a company’s top management as an outside investor can be a tall order, but savvy investors learn to tell from interviews and public statements whether a company has competent people at the helm. This may be an intuitive evaluation, but it’s probably an accurate one, too. If your gut is telling you to be cautious, don’t let the numbers convince you otherwise. But if the people at the top have a proven track record, that’s another check on your investment list. For the individual investor, connecting with a financial professional can open up new investment insights, as brokers and fund managers often have the opportunity to meet with management teams to get a sense of the state of the C-suite.
3. Consider the goal of each individual investment.
Some investments are about anticipating predictable dividends based on a company’s financial performance to date, while others are about jumping on a far-horizon growth opportunity that could multiply your returns. Similarly, some investors may be looking to turn over stock fairly quickly, while others may be aiming to fill out their long-term portfolio. Correctly segmenting your investments is important. Consider the Russell 1000 Growth Index, which has tracked significantly higher than the Russell 1000 Value Index in recent quarters, or the S&P/TSX Indices, which can be useful when tracking hot sectors and monitoring your investment goals.
4. Be cautious of influencing factors.
You form stronger opinions of products you experience firsthand, and that initial impression holds a lot of sways. Research shows that gut feelings are actually complex calculations that can override an investor’s typical approach to risk and uncertainty. Investors must be cautious of the fact that the more we like a particular product—or the individuals behind it—the more willing we are to invest unwisely. If an investment is threatening to run away with you, sleep on it or reach out to an advisor for a gut check.
5. Make sure the numbers add up.
Enthusiasm can quickly become irrational, which is why every investment must be subjected to financial due diligence. Things like the financial health of a company, its cash on the balance sheet, and its calculated market potential can’t be ignored—no matter how enticing the risk may be. Determine what comparable companies trade at and whether there’s a reasonable prospect of a return on this opportunity. Essentially, look before you leap.
There’s a difference between following your gut and making an impulsive decision. Knee-jerk reactions are an immediate response to the highs and lows of the market—they make sense in the short term but fail to account for the ongoing, unpredictable consequences.
The goal of every investor is to maximize returns. The gut reveals where to look; the head reveals how to act. Investors who follow one or the other will either be shocked by their losses or disappointed by their gains. The opportunity for investors is to balance each and trust both.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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