Last Updated on March 31, 2025
Overview – Fear and Optimism Are Always Present
It’s no mystery that emotions and investing are closely related, but of all the emotions that investors go through, two dominate the investing world: fear and optimism.
No matter how stoic or rational they claim to be, every investor is prone to reacting to fear or optimism. This isn’t to say they will let their emotions constantly get the best of them, but it would be naive to think they’re immune.
To make matters worse, whenever fear or optimism infects the minds of investors, it spreads to other investors, too, leading to a sort of “mind virus” that affects countless, unknowing victims.
Fear and optimism have repeatedly influenced the investment decisions of countless investors throughout history and will continue to do so well into the future, usually for the worse. In the following sections, we will examine how fear and optimism can affect investment decisions and how to deal with these dangerous emotions.
How Fear Can Affect Investment Decisions
Whenever fear starts to grip the hearts of investors, one of the first things that crosses their minds is the desire to act immediately.
When flash market crashes happen, many investors are quick to start panic selling or, at the very least, think about doing so. Anytime unfavourable economic news is released, such as lower quarterly GDP, increased unemployment, or negative business sentiment, some investors immediately ask how to hedge their portfolios against these downside risks.
Although taking action to counter any perceived threats to their portfolio seems logical, many investors act in response to fear primarily to allay their worries, not because it’s the logical thing to do. We’ve previously discussed how choosing to do nothing is, at times, a valid option, yet many investors seem to forget this.
Additionally, fear may cause some investors to adopt an overly defensive investment stance, even if such protectionism isn’t warranted or even damaging. Responding to perceived threats to their portfolio or goals is important, yes, but that doesn’t mean investors need to compromise their long-term goals for the sake of countering short-term emotions.
For example, investors who have recently decided to expand their portfolios into the European and Asian markets don’t need to forego this if these markets experience temporary bouts of volatility or occasional economic weakness.
Fear taking over the minds of investors is so dangerous because it can spread very easily, leading to more investors making poor, misguided investment decisions, generating even more fear. This is a vicious cycle in which individual investors may find themselves caught up if they fail to stay alert and keep their emotions in check.
Many investors are quick to drop their rational thinking and let fear influence their investment decisions and subsequent actions, and in doing so, put their portfolios and investment goals at risk.
How Optimism Can Affect Investment Decisions
If there’s one thing investors seem to constantly be in short supply of, it’s good news. Very few, if any, investors will say, “There’s too much good news going on”. Herein lies the problem.
An abundance of, or a handful of, high-impact good news can create a very powerful sense of optimism among investors, giving investors a false sense of security and invincibility. After all, with so many positive developments going on around them, what’s there to worry about?
Investors afflicted with this sense of euphoria may go on to make some very reckless investment decisions, such as indiscriminately acquiring popular investments without performing proper analysis beforehand or succumbing to the fear of missing out on “once in a lifetime” opportunities. Faced with a wave of optimism, many investors will view almost anything through rose-tinted glasses.
This has been observed repeatedly throughout history, whether it was the tech stock craze in the early 2000s, the meteoric popularity of mortgage-backed securities in the mid-2000s, or the crypto crunch in the early 2020s.
Worse yet, uncontained optimism may cause investors to relax or, worse, neglect their risk management processes due to a sense of it being redundant or unnecessary. This may lead investors to inadvertently shoulder more investment risk than they can realistically handle, putting their portfolios on very thin ice.
Just like fear, optimism can also rapidly spread to other investors, quickly creating a sense of uncontained hype, thereby generating even more optimism in a sort of positive feedback loop. It’s easy to discard logical thinking and forget about any consequences when inundated with good news and optimism.
Figuring Out if Any Fear or Optimism Is Justified
When faced with excessive fear or optimism, it’s tempting for investors to let it get to their heads and potentially influence their investment decisions. However, there is one relatively simple way to prevent that from happening, and that is to discern whether any ongoing fear or optimism is justified.
How many times in your life have you witnessed people get overly scared or excited over something, but upon further investigation, realize there was no substantial basis to justify such reactions? Many people are quick to succumb to how others are feeling without taking the time to stop and figure out where these feelings originate from.
The same observation can be made in investing, where the consequences can be much more severe. Fortunately, discerning if any fear or optimism is justified isn’t a trivial task, but it certainly doesn’t have to be overly complicated either. It’s simply a process of verifying whether the facts support how investors are currently feeling.
For example, if many investors start to talk about panic selling, market indices are down, and talks of recession dominate news headlines, investors can verify if fear is warranted by familiarizing themselves with pertinent current events and carefully looking through any relevant data.
Investors who choose to act before discerning if what’s going on around them is worth responding to is, almost always, a recipe for disaster. Just because thousands of other people act a certain way doesn’t automatically mean their behaviour is justified. A handful of facts is worth more than the emotions of thousands of strangers.
Take Action Only After the Situation Has Been Assessed
Taking the time to discern if any fear or optimism is justified is crucial because it will directly impact what sort of actions investors need to take, if any.
Based on an investor’s assessment, sometimes immediate, drastic action is necessary, whereas in other cases very little, if anything, needs to be done. After all, knowing when to take action is just as important as knowing when not to. Taking urgent action and doing nothing at all represent two extremes of the “action” spectrum: most investors will likely find themselves somewhere in the middle.
During the onset of the COVID-19 pandemic, investors around the world were rattled, and understandably so. However, many of them were quick to make hasty, irresponsible investment decisions in light of a rapidly evolving event. Those who decided to take a “wait and see” approach to better understand how the pandemic would unfold and how they’d be affected were less likely to have made the same mistakes.
Early in the second term of US President Donald Trump, his announcements of sweeping tariffs shook financial markets around the world, and countless investors tried to make sense of his remarks and potential next moves. Those who ascertained these tariffs to be a serious threat to their portfolios would’ve needed to act quickly, while those who realized the tariffs would have minimal effects wouldn’t have needed to do much.
When overcome with fear or optimism, many investors make the mistake of taking action without first finding out if it’s necessary. Taking the time to stop before you leap can make all the difference and can spare investors from wasted time and effort or, worse, long-term damage to their portfolios.
Wrapping Up
While investors can succumb to all sorts of emotions, the two most prevalent, and arguably the most damaging, are fear and optimism.
When gripped by fear, investors may feel inclined to perform some kind of action to allay their worries, even if nothing needs to be done, or may adapt an overly defensive investment stance.
Conversely, overly optimistic investors may think themselves to be safe or invincible, leading them to acquire highly speculative financial instruments or shoulder exorbitant amounts of investment risk.
To help counter this, investors will first want to assess whether any ongoing fear or optimism is justified, and if so, determine how much action is needed. Sometimes, quick, decisive action is necessary, whereas in others, there’s no real need to do anything at all.
