Feeling Machines: The Emotional Cost of Buying and Selling

Any hypothesis about the future has inherent practical limitations. We don’t have a complete understanding of the past and the future is always uncertain. These are unavoidable constraints that burden our investment decision making and carry with inherent emotional costs.

These costs are compounded by our vulnerability to cognitive and emotional biases, both our own and those of everyone involved in the decision-making process.

But which of the basic investing processes — buying or selling — exacts the steepest emotional toll from us?

Emotions: Necessary Inputs to Decision Making

Emotions, thoughts, and actions are inextricably tied together. Modern psychology and neuroscience confirm that emotions can be traced to the old reptilian parts of the human brain. As a consequence, we demonstrate an entrenched bias toward avoiding unpleasant or negative emotions, like guilt, fear, and regret, and seeking out positive ones, like pride and happiness.

A lack of awareness about the interplay between emotions and actions can lead us away from logical, realistic choices. But idealizing cold rationality and treating emotion as a weakness may be counterproductive and a bias in itself. We need to appreciate that emotions are an evolutionary response to uncertainty and that they are actually necessary for reliable decision making. Indeed, some behavioral biases can be helpful.

We asked CFA Institute Financial NewsBrief readers to rank their investment activities based on the emotional difficulty they associate with them. The 711 responses we received from our global audience highlighted some interesting patterns.

Which investment activity is emotionally the most difficult?

An overwhelming 84% of respondents found selling, specifically selling and short selling, to be more mentally costly than buying. This result reflects our bias towards ownership, also known as the endowment effect. We tend to overvalue everything that is ours, from our thoughts to our investment assets — even if some of the things that we come to own are detestable.

Selling was ranked as the most emotionally taxing investment activity by 43% of participants. We can objectively calculate investment success at the point in time a sale is made. Obviously, given a limited time frame, there is at least a 50% chance that regret — an important emotional bias — might follow a sale. That sense of regret is immediate when the sell price is below our buy price. Of course, the pain could come later, if the asset’s value rises well above what we sold it for. So how do we avoid these sorts of negative emotions? By doing the impossible: timing the market perfectly and always selling at or near peak value.

Selling short was rated hardest by 41% of participants, coming in second just behind selling. This was something of a surprise. After all, short selling tends to be a riskier activity and often involves playing with borrowed money. Barton Biggs, in his engaging book Hedgehogging, dedicates an entire chapter, “Short Selling Is Not for Sissies,” to the topic and provides an engrossing account of how short sellers risk losing their shirts. Obviously, our short sell call may be correct, but the perceived value of the asset being shorted may not fall as expected within our investment time frame. Hedge fund manager Bill Ackman recently commented that short selling was “not worth the brain damage.”

Buying on margin was rated the most emotionally difficult activity by 13% of poll participants compared to 3% who selected buying. Survey respondents were logical to weigh the mental costs of margin buying higher than simple buying. As with short selling, buying on margin involves using borrowed money and this opens us up to potentially losing more than what we invested.

Neuroscientist Antonio Damasio maintains that human beings “are not either thinking machines or feeling machines but rather feeling machines that think.” Every activity — not just the buys and sells in investing — leaves an indelible marker of pleasure or pain. These markers provide input for future decision making when we encounter similar situations.

Listening to and interpreting these markers and emotions influences our choices and helps lead to well-deliberated investment outcomes.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.