To know and understand the motivating forces behind investing, to know and understand why one investor becomes tense about losses, why one becomes greedy about profits, and why one either overreacts or fails to react is, perhaps, more than half the investment battle. There is a high price to pay for the kind of innocence many investors bring to their investments and the way they interact with their investment advisors. Unfortunately, in many cases, to help maximize your clients’ financial returns, you must first help them master their emotions.

Often, bull markets are like blinders. Investors begin to believe in the fantasy that their stocks will always take good care of them and never disappoint them. But, when reality hits and the bull market turns bear, investors can be faced with challenging decisions and their gut emotions may take over.

In my 27 years of experience, as a psychologist specializing in the psychodynamics of money management and investing, I’ve come to realize that there are certain important relationships which we must understand before we may be able to achieve a consistent degree of success in the world of investing and in the marketplace. The first and foremost of these is that the majority of losses in the marketplace result not from poor trading decisions but rather from emotional and attitudinal causes. Investing by its very nature is an emotional business. Few investors have the self-knowledge, emotional stamina or self-control to make rational, intelligent and profitable decisions, particularly in times of stress. So often, investors react wildly to bad news, frequently selling shares of perfectly good stocks–reacting with their emotional money minds rather than their rational ones.

Why is it that some investors may tend to make rational decisions, stick with their choices and strategies while others seem to act out their emotions and make investment decisions that may not lead to profit?

The field of behavioral finance has given insight into some mental miscues investors make that might sabotage and crimp their returns:

Fear of losing money – Psychologically, people give greater weight to a past loss than they do to a future gain. In fact, some individuals find losing money so distasteful that they talk themselves out of investing altogether. Some investors don’t make reasonable trade-offs because the drive to avoid loss sabotages any future gains or opportunities.

Possible Solution: Determine ahead of time exactly how much your clients can “emotionally” afford to lose as well as “financially”. They are often very different.

Worrying about the wrong risks – Investors are held captive by events that could be conceived as unpredictable or frightening events. People are traumatized by dramatic events. They can’t tolerate the anxiety that accompanies them. Investors often become blind and deaf to others’ advice in these times and tune out advice from others, including their financial professionals. They exaggerate current crises. What’s worse is that they forget the wisdom of lessons from the past. They overlook the fact that people who stayed fully invested during previous crashes recouped their losses.

Possible solution: Help investors base their decisions on what they can control, not on those factors they can’t control. Review the rationale for their current strategy and ask them if they feel it still makes sense based on everything you and they know at the time. If it does, review why the strategy still makes sense from time to time so you can help regulate any impulsive and emotional reactions that may bring them off course.

As you evaluate your investment strategies and investors’ individual situations, consider these points:

– Investors are more prone to make or lose money as a function of their emotions and attitudes than on the basis of their stock selection or trading system.

– The best system can be rendered a losing proposition by inappropriate implementation due to emotional and behavioral limitations.

– Appropriate or successful investor behavior can be learned to a large extent. Education is essential to helping investors stay in control and continue to grow, particularly in learning self-regulation and self-control.

Acknowledging and understanding your clients’ emotions is an important step in helping them stay on track with their long-term financial plans when challenging economies become the everyday reality. Likewise, helping them learn how to control their emotions even when the market turns upwards is equally important. Finally, encourage them to call at any time if they find themselves questioning their decisions and that you are always there to help when they have to make the tough decisions.

Copyright 2010 Kathleen Gurney, Ph.D.