When it comes to retail investors, we all know too well that emotions can get in the way of making smart decisions about investment portfolios. All too often investors buy high (when greed sets in and they see that markets going in a positive direction) and sell low (when fear sets in). But a new study by psychological scientist Jennifer Lerner of the Harvard Kennedy School of Government shows that sadder investors will get higher returns in the short term but lesser gains in the long term. But investors in a “neutral-state”—those not subject to instant gratification—made more money over the longer term.
According to the research, published in Psychological Science, a journal of the Association for Psychological Science, sad investors earned less money because they showed a “present bias,” meaning they wanted immediate gratification and ignored greater gains associated with waiting.
“Across three experiments, the median sad participant valued future rewards (i.e., those delayed by 3 months) 13% to 34% less than did the median neutral-state participant. These differences emerged even though real money was at stake and even though discount rates in the neutral condition were already high,” the authors reported.
“These experiments, combining methods from psychology and economics, revealed that the sadder person is not necessarily the wiser person when it comes to financial choices,” they concluded. “Instead, compared with neutral emotion, sadness — and not just any negative emotion — made people more myopic, and therefore willing to forgo greater future gains in return for instant gratification.”
So not only do these people have to deal with the fact that they’re sad, they also have to deal with the fact that they have less money. And the cycle continues…