Emotional Risk: The Little Known Factor That Kills Investments

We hear a lot about risk, but what is risk?

In any finance class, you will hear about two types of risk:

Market Risk: The possibility of your investment losing value due to events affecting the entire market. Examples: Recession, interest rates being raised, natural disaster, etc.
Investment Specific Risk: The unique risk of any given investment not determined by market conditions. Examples: Your investment properties roof collapses, tenants fail to pay rent, etc.

While these risks are important to understand, one type of risk can multiply the severity of market and investment specific risk.

Emotional risk.

So what is “emotional risk?”

Emotional risk: Decisions guided by emotions rather than investment principles.

I’ve read numerous stories about real estate tragedies. A common theme among these failures is a lack awareness of emotional risk. Real estate investing is a long term journey. Unfortunately, many people are shaken out of the game before they can gain vital experience necessary for success.

Emotions are what make us human. The love you feel for friends and family, and the hatred you feel for cable companies. But too much emotion can cloud your judgement. Now, we can’t turn ourselves into robots and assume we will never make emotional decisions, but we can identify our emotional triggers to recognize when we are in the grips of emotion.

Emotional risks takes numerous shapes and sizes. Everyone handles their emotions differently, so there’s no one-size-fits-all policy. The best way to control emotional risk is to have a deep understanding of possible triggers causing emotions to run rampant. By having this awareness, you can decrease the power your emotions have over your investment decisions.

“If you cannot control your emotions, you cannot control your money” – Warren Buffett

Triggers of Emotional Risk

Failing to Clearly Define Your Personal Real Estate Goals

To summarize most newbie investment goals: GET RICH! Define “rich.” Do you define rich as being able to buy whatever you want? Do you mean early retirement? Or being able to turn off your cellphone after work so you can spend time with your kids? Will more money fix your current spending issues?

Thinking Real Estate is a Salvation to All of Your Problems

Do you believe investing in real estate will help you solve your personal problems? Are you telling yourself the grass is greener in real estate investing because you can run away from your problems? Do you think you won’t have to work anymore once you begin investing in real estate?

Lack of Personal Awareness of Your Emotional Climate

Do you tend to be a negative person and find all the weaknesses in a deal? Or does your positivity blind you from potential risks? How do you handle setback? Are you someone who has a low emotional boiling point?

Unnecessary Time Pressure

Do you feel a need to immediately jump into real estate investing because you missed a “great opportunity?” Do you find yourself saying, “I’m not expanding my housing portfolio fast enough”?

Investing Your Ego Instead of Capital

Do you personally tie your self esteem to the value of your investments? Are you comparing your investment success to others? Do you find yourself saying you’re better than other investors and you can handle riskier investments?

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” – Warren Buffett

Poor Family Planning

Have you sat down with your partner to discuss the time commitment involved in real estate investing? Have you met with anyone who’s involved in real estate investing? What are the repercussions leveraging yourself to the hilt for a “sweet deal?” What happens if you’re unable to manage your investments? How will your family take care of them?

Failing to Understand Not All Growth is Created Equal

Do you understand the difference between controlled, steady growth and rampant growth? Steady growth can be maintained without destroying the integrity of your systems and allowing you to stow away enough cash for a rainy day, improve systems, and strike when a good deal appears. Or are you driven by the latest “game changing” fad and are you willing to risk it all for a short term gain? To learn more about rampant growth and its destructive power, check out Podcast #1.

Jack of All Trades and Terrible at Them All

Not all greed is financial. Greed can be in the form of trying to master all real estate niches at once, which results in learning a little about a lot and doesn’t allow you to build momentum in any niche — when in all reality, many have spent their entire lives just trying to understand one aspect of real estate investing.

“The road to real estate ruin is paved by greed.” – Fortune Cookie

Sheep Mentality

Are you investing in a given market because Fred down the street recommends it? Do you know Fred’s investing goals? Is Fred down the street following the same investment criteria as you are?

This is by no means a complete list of each and every trigger to emotional risk, but it’s a starting point to examine your own motivations and assumptions.

Remember, we can’t control the market or what will happen to our properties, but we do control how we react to those situations.

What Types of Emotional Triggers Do You Think I Missed?

Now that we have thought about our potential risks, let’s build an investment plan with personal checks and balances to minimize our emotional and financial risks and hold us true to our investment goals. Stay tuned for part 2!

What would you add to my list? Have any of these emotional triggers affected your decisions as an investor?

Leave your comments and stories below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.