Go Ahead. Be Emotional.

The world of investing is full of contradictions, or at least what appear to be contradictions. Consider these nuggets of advice, for example:

1) Don't waste your time trying to time the market. Always remain invested in stocks.
2) Don't be afraid to stay out of the market, at least partially, for a while. Wait for the fat pitches.

1) Don't add money to a falling stock position.
2) Use dollar-cost averaging, investing regularly in a stock whether it's up or down.

1) Buy and hold forever (or at least for a very long time).
2) Sell when something much better comes along.

1) Let your winners run.
2) Rebalance your portfolio when one or more stocks grow to dominate it.

See? It can be confusing. I recently discovered another contradiction. You, like me, have probably heard plenty about how good it is to be a calm, cool, rational investor. That certainly makes sense. I know we should try to be objective, evaluating data and making logical decisions. But now there's a new study out that suggests the opposite.

In a recent issue of the Academy of Management Journal, Myeong-Gu Seo of the University of Maryland and Lisa Feldman Barrett of Boston College reported on a study in which they observed 101 participants in a four-week-long trading simulation. They found that, "[c]ontrary to the popular belief that the cooler head prevails, people with hot heads -- those who experienced their feelings with greater intensity during decision-making -- achieved higher decision-making performance."

But, but ...
Yes, I know this may seem a little wacky. And just to be clear, the professors pointed out that emotion alone isn't the key. According to the study, those who understand their emotional states are more likely to be able to control those emotions, avoiding bias and leading to better results.

That makes more sense. Consider fear and greed, two emotions that are part of investing for most of us. If we recognize when we're feeling greedy, instead of acting on that (perhaps by buying into a risky stock, or holding on to a stock that may have soared too much), we might be able to use our recognition of the greed to temper our response. We might opt not to buy the stock because we want to counter our unhelpful emotion of greed. Similarly, when fear makes us want to bail, our awareness of that fear might help us overcome it and hang on.

In addition, if we're feeling emotional regarding our investing, we're more likely to be interested in it and to take action. We're more likely to care, rather than ignoring it. In this sense, our emotional investment in growing our money can be a good thing.

If the will isn't there
For many of us, though, the passion just isn't there. Yes, of course we want to make money -- we know we need to, for our retirement and other goals. But for many, it's simply not exciting to watch stocks and funds go up and down. There are just more appealing things to do than study investments and allocate money. If you find yourself in this camp, here are two good options for you:

  • Invest in some carefully chosen mutual funds. Once you do so, you won't have to monitor them too often, and you can enjoy having smart money managers making investment decisions for you. If you'd like some help zeroing in on some outstanding funds, I encourage you to take advantage of a free 30-day trial of our Motley Fool Champion Funds newsletter, which offers some terrific fund recommendations monthly in an easy-to-digest format. (I've found a bunch of winners there myself.) Its picks are beating the market by some 11 percentage points. A free trial will give you full access to all past issues, so you can read about each recommendation in detail.
  • If even that seems like a lot of work, you might just opt to invest in a broad-market index fund, such as the Vanguard Total Stock Market Index Fund (VTSMX) -- or its ETF cousin, the Vanguard Total Market ETF (AMEX: VTI  ) . Just one investment puts you into well-known companies such as General Electric (NYSE: GE  ) , Procter & Gamble (NYSE: PG  ) , Cisco Systems (Nasdaq: CSCO  ) , and Johnson & Johnson (NYSE: JNJ  ) .

My own bottom line, having read about this research, is that it's still critical to be rational in our investing -- but that we might also do well to be aware of our feelings.


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