The Emotional Cycle of Investment Decision-Making
It can be a challenging task to manage an investment portfolio on your own. Despite the challenges, many people forge ahead and do not seek help from a financial advisor. While there are many aspects that need to be understood and addressed when managing finances, one particular aspect is the potential impact of social media on financial decisions.
First, let’s review the emotional cycle that many people face when making an investment decision. The set of emotional triggers surrounding purchase and sale decisions can cause us to make costly mistakes. For instance, you hear that an investment has done well (maybe from a friend or associate), so you buy it after learning about its short-term period of good performance, at or near the peak of the shorter-term pricing. As it begins to decline in value, you convince yourself that it is still a great investment and that you should hold onto this security for the long haul, continuing your emotionally-based decision-making process. When the investment declines further in value, the emotional pain of holding it becomes much greater. At some point, usually near the bottom of the pricing cycle, you fall out of love with the idea of this investment and decide you can’t take it any longer, so you sell. By reacting in this fashion, you have essentially created a pattern of buying at higher prices and selling at lower prices.
If you repeat this process, you are likely not putting yourself in a fruitful long-term financial position. Quite the opposite. You are probably reducing your wealth by operating in this emotional cycle. Why does this happen? This is a natural result of emotions driving investment decisions. One of the most difficult parts of managing your own investment process is to do so without emotion. In fact, it is virtually impossible for many people.
So, what happened to the friend that recommended this investment? You have no idea? People may tell you about investments, but they generally don’t provide a detailed list of their track record. They may likely have had a much less rosy experience than the one that they portrayed. But, it is certainly fun to tell these stories at social gatherings. This is a form of the big fish story of the next generation.
However, there is someone that benefitted from your roller coaster of buying and selling- the broker that placed your trades. They probably earned a commission for transacting your purchases and sales. The trader that executed the trades also may have priced the bid/ask spreads in a way that was advantageous for them. In fact, they might make a profit regardless of the performance of your investment.
Investors are Using Online and Social Media Resources
Social Media Grows in Use and Influence
Cogent Research recently released a study showing that social media is playing an influential role in the decision-making process of individual investors, including those that can be considered high net worth investors. They learned that of the adults online in the US, one out of four are using social media with a specific focus on personal finance and investing.1 And, it is not limited to people with fewer resources. On the contrary, high net worth adults that are online are using social media for investing purposes at a rate that is higher than the general population! Almost two-thirds of high net worth investors say that the online groups and peer-generated information has an influence over their purchasing behaviors and decisions.2
Consider the Source
It is interesting (and scary!) to note that while many investors are seeking out peer groups, they generally are not relying on official sources of information. More than half of high net worth investors have questioned the accuracy of information received from official sources because of what they have heard through social media.3 Let’s think about that. Instead of trusting factual data, many high net worth investors are questioning it and relying on advice presented in social networks. It is very difficult to get reliable and helpful information when you are engaged in a giant game of “telephone”.
Indeed, social media networks may provide emotional support in the form of positive feedback on financial decisions. Although getting support is great, social media can contribute to the emotional roller coaster of investing described above. Investors may be relying on a social media source that contributes to emotional investment decision-making while concurrently reducing their reliance on accurate data from official sources.
The Online World and Social Media
It is worth noting that the social media space is big! Globally, about one billion people are connected to the internet.4 Smart phones that are data-capable represent over 50% of new phone sales.5 And, it is believed that more than 400 million people are sharing their experiences and opinions via weekly online exchanges.6
The social media network is also a larger and looser network than many individuals’ personal networks of trusted friends and colleagues. The average Facebook user has 130 friends, although younger users tend to have more, usually associating with around 1,000 friends and sometimes even significantly above that.7 While you may not call all 130 (or 1,000!) of these people for coffee, you in fact may find that your network of people on social media sites is quite a bit broader and quite a bit more untested. In fact, a post from a person on a networking site may influence your decision making through their positive or negative feedback.
And, it is this influence that can contribute to the emotional cycle of investing.
Benefits and Cautions about Information Gleaned Online
As always, the internet is an amazing tool with an amazing amount of data out there. The key is to discover how to use the data to learn how to create a framework for improving your finances.
Using online and social media may help you learn more about an advisor through client reviews. This can give you some insight into how that advisor works and allow you to evaluate whether their approach appeals to you. Of course, you typically find that testimonials trend to either the high or the low. People rarely report a middle-of-the-road experience. And with primarily high and low experiences to rely on, you may have to discern what role the individual played versus what role the advisor played in the relationship(s) being reported upon. But such reviews are a way to learn about what the service experience was like and where an advisor could provide help. You may find an advisor that seems well-suited to you and be able to research the advisor’s background and qualifications.
However, the social media space is not a great place to obtain investing tips! Other social media users’ stories can be like the cocktail party story run amok. “I bought a great stock last month and it doubled in value!” There is no vetting of the individual making the claim. There is no monitoring of their history of comments and recommendations. And, there is certainly no regulation of how they claim successes. Anyone can make a claim on a social network that they have an amazing track record. But not everyone may make baseless claims online. For example, registered investment advisors may risk liability for what they publish or recommend online. So, the one group you will not usually hear from in a public forum is the group that may actually have the background to evaluate your financial situation and make recommendations for you. Ironic, but for the most part true.
Social Media can be great for making connections with friends, family and colleagues. The internet is a good tool to use to research factual data (not advertisements) and look up an advisor’s background information. Also, before you hop on the social media bandwagon, take some time to think about what you need. Do you need help with your financial decisions? It is usually a great idea to avoid getting tips from peers, whether they are someone you see at a party or someone you find online. Instead, you may want to consider seeking an expert’s opinion and endeavor to break free from the emotional investing cycle.