Investing in the mirror

Emotions and opportunities beyond fear

Investing is not just about calculations, ratios, analyses
and figures.

It's also about emotions, ranging from hope and euphoria to overconfidence and fear. In this special, we explore the role that psychology plays in investor behavior and how to learn to manage the various emotional states a person may experience, such as frustration or risk aversion. The most important thing is to have a plan.

Lucas had always dreamed of having his own farm, growing his own food and living off the land.

He worked in other farmers' fields for years, learning every technique and saving enough to buy a small plot of land and quality seeds.

All the while, Lucas wondered if it would be worth risking his savings, if the crops would be enough to feed him, and if people would buy his produce.

He had his doubts, but he was determined.
Most importantly, Lucas had a plan.

Now he’s laid out his crops, studied the market, and applied modern techniques to maximize production. Despite periods of drought, extreme weather, and tough years, his plan allowed him to produce enough in the good years to get through the bad ones.

When asked why he succeeded and never gave up, Lucas replied, “I had a plan”

He was always prepared for the years when the harvest wouldn’t cover the costs and would lead to losses. Investing is much the same. Even if there are difficult years, if you prepare during the good years and save enough of your profits, success will follow.

The psychological role of investing

Behavioral Finance

In the early 1980s, a previously overlooked area of economics began to gain traction: Behavioral Finance.premièred 36 years ago.

Hersh Shefrin Meir Statman
Hersh Shefrin and Meir Statman

They were the first economists to discuss the impact of biases and emotional factors on economic decisions.

1980
Kahneman Smith
Daniel Kahneman and Vernon Smith

In 2002, this field was fully consolidated when Kahneman and Smith received the Nobel Prize for their work on behavioral economics.

2003
Robert Shiller Richard Thaler
Robert Shiller and Richard Thaler

Two more Nobel Prizes followed, awarded to Robert Shiller and Richard Thaler for continuing to explore the interplay between emotions and economic decision-making.

2013-17
In recent years, BBVA has been a pioneer in developing a dedicated Behavioral Economics department.

This department has fostered a culture of Behavioral Economics, which has since evolved into a more strategic vision of the area's role, scaling up its execution capabilities and aiming to be present in every “C” of a project.

Today

Behavioral economics has grown in popularity across various industries. Originally focused on public and social policy, it is now also being used to address a variety of challenges in business, health, sustainability and more. Events such as the financial crisis have highlighted the importance of helping customers make better financial decisions to avoid excessive debt, encourage saving, pursue medium and long-term planning and consider alternatives in the current inflationary environment. Today’s approach aims to promote customers' understanding of the benefits of certain behaviors and make them tangible so that they are more easily adopted.

Therefore, there are emotional and mental pillars that investors must learn to control. To succeed in their strategy, they need to know how to:

Manage losses
Handle uncertainty
Take profits
Seize opportunities

The importance of managing emotions when investing

The theory often seems easier than the practice. When investors invest their money in the capital markets, they do so for economic reasons— for example, to preserve their wealth, to protect themselves against inflation and often also to achieve growth in order to achieve certain life goals. However, these reasons tie in with volatile market situations that shake emotions, making decision-making far from the sterile process of doing a math operation or a mechanical procedure.

“When an investor manages their money, what they are really managing is their relationship with uncertainty, control, and the value they assign to money as a symbol (security, status, legacy)”
Manel Fernández Jaria Specialist in Team Leadership and Cohesion

According to Fernández Jaria, emotions are not inherently negative. The decisive factor is the intensity of the emotion, because it influences the behavior we exhibit and is shaped by our feelings.”

To summarize what we have discussed so far, Pedro Serrano, Professor of Finance and Business Administration at Carlos III University in Madrid, stresses the importance of observing investor behavior during market crises.

“The widespread drop in prices witnessed between February and March 2020, when we saw a 32% correction in just 18 trading sessions due to COVID, seems to be explained more by a major shift in investors’ perception of risk, a significant shock to their risk aversion, rather than by changes in expectations of the cash flows of the companies behind those shares.”

Historic stock market crashes 1929 - 2020
Historic stock market crashes
Historic stock market crashes 1929 - 2020
Historic stock market crashes
1929 - 2020
The Great Depression -86%
Second World War -60%
Inflationary Crisis -30%
Flash Crash 1962 -30%
Inflationary Crisis -50%
Black Monday -34%
Tech Bubble -52%
Global Mortgage Crisis -57%
Pandemic crisis -35%
Inflationary Crisis -27%

In the period referred to by the professor, emotions overwhelmingly took precedence over reason, triggering the fourth largest stock market drop in history. In fact, nothing of the sort had been seen in this century since the collapse of Lehman Brothers, when the Dow Jones plunged by 50%, or the bursting of the dot-com bubble at the turn of the millennium, the worst crash of all, with corrections in some cases reaching as much as 80%.

The lesson lies with those investors who managed to keep their emotions in check and didn’t sell in a panic. Those investors were the ones who achieved great returns. In fact, that same year, 2020, the S&P 500 saw an 18% increase despite the correction that shook the markets.

Emotions an investor should monitor

According to Liliana Jiménez, an expert in psychotrading, “managing these emotions and controlling cognitive biases is essential to maintain discipline and consistency in an investment strategy.premièred 36 years ago. Without proper emotional control, investors stray from their original plan, acting under the influence of panic, greed, or excessive optimism.”

There is an even more subtle emotion than panic: is uncertainty. It’s the phase when markets lack clarity, when dangers lurk, or perhaps when a stock has risen so much that the question becomes: will it keep rising?

But what happens when markets go up? Greed can take hold of the investor, leading them to believe gains are unlimited. The most common advice is: don’t sell in panic, and don’t buy in euphoria.

Listen to it
Manel Fernández Jaria
Uncertainty
Manel Fernández Jaria
Pedro Serrano
Overconfidence
Pedro Serrano

The 10 biases to watch out for

Experts have identified several preconceptions that you should be particularly wary of when investing. Let's analyze them to keep these biases from becoming obstacles.

Confirmation bias

We tend to focus on information that supports our pre-existing beliefs.

This bias occurs when investors only seek and pay attention to information that confirms their views and ignore anything that contradicts them. It can be a significant danger as it downplays risks and potential challenges that should be considered.

Confirmation bias
Projection bias

We assume that our current situation and preferences will remain unchanged over time.

Many people project their current circumstances into the future as if life were static. However, circumstances change; we change jobs, our standard of living shifts, and many other factors come into play. All of this affects the financial strategy. While it’s important to have a long-term plan, it’s also crucial to adapt it to our needs at any given time so that we feel secure in our investment portfolio.

Projection bias
Cognitive overload

An overwhelming amount of information or too many choices can lead to decision paralysis.

When investors are faced with a flood of opinions and analysis, they can struggle to decide which path to take. This confusion often leads to postponing investment decisions in the hope of gaining more clarity later. While this can be beneficial in some cases, it can also lead to missed investment opportunities.

Cognitive overload
Overconfidence

We tend to overestimate our ability to achieve our goals and the likelihood of a favorable outcome.

While successful investing is the ultimate goal, overconfidence can lead us to take unnecessary risks. In such a mindset, we often fail to consider the risks involved and the possibility that a particular investment may not go as planned.

Overconfidence
Herd mentality

We often follow the crowd, allowing ourselves to be swayed by majority opinions and trends.

Few things are more dangerous than making decisions just because everyone else is doing the same. This tendency can create bubbles and lead us to overlook the objective valuations of an asset, which can lead to significant losses.

Herd mentality
Anchoring bias

We prioritize the first analysis or opinion we come across over any subsequent information.

This occurs when an investor reads that a particular asset, sector or country will be successful in the future and stops looking for further information or opinions. This situation can lead to confirmation bias.

Anchoring bias
IKEA effect

We place a higher value on things in which we have invested effort.

If we have worked hard to educate ourselves and develop a personal investment strategy, we are likely to value it more than the suggestion of a financial advisor. However, working together and sharing ideas can often lead to better results, even though we may value our own contributions more. But that doesn’t diminish the value of others' efforts.

IKEA effect
Status quo

We tend to accept the status quo and stick with familiar routines.

While it often lurks beneath the surface, it can be particularly relevant when evaluating an investment strategy. Investors may prefer the comfort of their existing investments rather than seeking change. For example, if a new fund comes to market that offers better returns or lower fees, investors may choose to do nothing rather than switch to a more attractive option.

Status quo
Loss aversion

Losses hurt us more than gains please us.

Loss aversion often occurs during market corrections and leads to fear. This tendency is particularly common among overly conservative investors or savers. In some cases, it can cause wealth to stagnate because people become overly cautious.

Loss aversion
Preference for the present

We often seek immediate gains and underestimate future benefits.

This tendency may be to our advantage or disadvantage depending on market conditions. It reflects a tendency to prioritize short-term gains over long-term potential. In investing, a sharp rise in the value of an asset can cause many investors to exit early rather than hold. In hindsight, this tendency can lead to great regret.

Preference for the present
Confirmation bias

We tend to focus on information that supports our pre-existing beliefs.

This bias occurs when investors only seek and pay attention to information that confirms their views and ignore anything that contradicts them. It can be a significant danger as it downplays risks and potential challenges that should be considered.

Projection bias

We assume that our current situation and preferences will remain unchanged over time.

Many people project their current circumstances into the future as if life were static. However, circumstances change; we change jobs, our standard of living shifts, and many other factors come into play. All of this affects the financial strategy. While it’s important to have a long-term plan, it’s also crucial to adapt it to our needs at any given time so that we feel secure in our investment portfolio.

Cognitive overload

An overwhelming amount of information or too many choices can lead to decision paralysis.

When investors are faced with a flood of opinions and analysis, they can struggle to decide which path to take. This confusion often leads to postponing investment decisions in the hope of gaining more clarity later. While this can be beneficial in some cases, it can also lead to missed investment opportunities.

Overconfidence

We tend to overestimate our ability to achieve our goals and the likelihood of a favorable outcome.

While successful investing is the ultimate goal, overconfidence can lead us to take unnecessary risks. In such a mindset, we often fail to consider the risks involved and the possibility that a particular investment may not go as planned.

Herd mentality

We often follow the crowd, allowing ourselves to be swayed by majority opinions and trends.

Few things are more dangerous than making decisions just because everyone else is doing the same. This tendency can create bubbles and lead us to overlook the objective valuations of an asset, which can lead to significant losses.

Anchoring bias

We prioritize the first analysis or opinion we come across over any subsequent information.

This occurs when an investor reads that a particular asset, sector or country will be successful in the future and stops looking for further information or opinions. This situation can lead to confirmation bias.

IKEA effect

We place a higher value on things in which we have invested effort.

If we have worked hard to educate ourselves and develop a personal investment strategy, we are likely to value it more than the suggestion of a financial advisor. However, working together and sharing ideas can often lead to better results, even though we may value our own contributions more. But that doesn’t diminish the value of others' efforts.

Status quo

We tend to accept the status quo and stick with familiar routines.

While it often lurks beneath the surface, it can be particularly relevant when evaluating an investment strategy. Investors may prefer the comfort of their existing investments rather than seeking change. For example, if a new fund comes to market that offers better returns or lower fees, investors may choose to do nothing rather than switch to a more attractive option.

Loss aversion

Losses hurt us more than gains please us.

Loss aversion often occurs during market corrections and leads to fear. This tendency is particularly common among overly conservative investors or savers. In some cases, it can cause wealth to stagnate because people become overly cautious.

Preference for the present

We often seek immediate gains and underestimate future benefits.

This tendency may be to our advantage or disadvantage depending on market conditions. It reflects a tendency to prioritize short-term gains over long-term potential. In investing, a sharp rise in the value of an asset can cause many investors to exit early rather than hold. In hindsight, this tendency can lead to great regret.

Is it easier to deal with fear or euphoria?

The experts consulted believe that while buying during periods of excessive optimism carries risk, it’s generally easier to manage. Despite this, acting under the influence of panic can be far more damaging.

Finance professor Pedro Serrano cites a study by asset manager Fidelity that analyzed customer accounts between 2013 and 2014. Researchers found that the best-performing accounts belonged to investors who were either inactive or deceased. “The main reason is that these investors didn’t make frequent changes to their portfolios, avoiding impulsive decisions triggered by market fluctuations or economic news. This inactivity protected them from common mistakes such as selling in panic or trying to predict short-term movements, which often lead to lower returns”, explains the professor from Universidad Carlos III.

"Fear is usually more harmful"
Liliana Jiménez
Liliana Jiménez
“Panic selling is worse"
Pedro Serrano
Pedro Serrano
How fear works in the brain We receive an external stimulus We anticipate danger Our imagination runs wild Fear grows We react physically • We analyze • We rethink • We redefine the experience to label it Store the experience Interpret Respond The 4 Fs of fear Fight (pelear) Flight (huir) Freeze (congelarse) Fawn (aceptación) Fear is an evolutionary response that can distort how risk is perceived.
How fear works in the brain
How fear works in the brain Fear is an evolutionary response that can distort how risk is perceived.

Keys to controlling your emotions

01 Exercises to stay calm
Manel Fernández Jaria Specialist in Team Leadership and Cohesion
02 Resort to financial advisers
Pedro Serrano Executive coach and specialist in executive emotional health

Pedro Serrano recommends seeking the help of financial advisors “to stay sane” when making decisions. “Having a trusted finance expert by your side can also help maintain discipline and avoid common investment mistakes driven by emotions, such as many of the cognitive biases”

03 Stick to the plan
Liliana Jiménez Specialist in psychotrading

Liliana Jiménez, an expert in psychotrading, advocates for staying true to the original investment plan. “Having a clear and well-defined strategy is also crucial, as a well-structured plan acts as an anchor against emotions, reducing the temptation to deviate due to momentary impulses.”

04 Keep a journal of emotions and decisions

As a final piece of advice, Manel Fernández Jaria, a specialist in Leadership and Team Cohesion, encourages investors to keep a journal of their financial decisions and the emotions associated with them.

Basically, the expert recommends keeping a notebook handy where the investor writes down the financial decisions they make and the emotions they felt at each moment. This allows them to analyze when they acted out of fear or overconfidence. By reviewing it, they can study when and how they made their best — and worst — decisions.

“It’s not about suppressing emotions; it’s about transforming them into strategic information. Emotions provide valuable internal data”

To conclude, a winning investment strategy is one that starts with a clear and well-defined plan, where decisions regarding portfolio structure and allocation are not driven by extreme emotional biases. This plan should target specific financial objectives and align with the investor's risk profile. Sticking to this plan and consulting experts is the key to success.

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