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Strong emotions make for good decisions in both investing and managing, study suggests

September 1, 2007

For more information, contact: Benjamin Haimowitz,

"Emotions are best saved for romantic dinners, junior's graduation, or cheering ol' alma mater." begins a popular book on investing. "When it comes to equity investing, though, they're a hazard."

Such is the conventional wisdom when it comes not only to picking stocks but making managerial decisions of all stripes: to the greatest extent possible, keep feelings out of it.

Now new research calls this nostrum into question.

Based on the monitoring of 101 stock investors in a simulated exercise spanning four weeks, a study in the Academy of Management Journal reports that "contrary 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 those who did best of all had something additional going for them, conclude the authors Myeong-Gu Seo of the University of Maryland and Lisa Feldman Barrett of Boston College -- namely, an ability to differentiate among the emotions they experienced. As the authors put it,

"The popular prescription for successful emotion regulation, 'Ignore your emotions,' appears, in view of our results, not to be the right answer... Instead, the results suggest exactly the opposite: individuals who better understood what was going on with their feelings during decision-making and thus reported them in a more specific and differentiated fashion were more successful in regulating the feelings' influence on decision-making and, as a result, achieved higher investment returns."

In short, "Know thyself," the injunction inscribed at the Delphic Oracle, would seem as useful for present-day investors and managers as it was for that ancient prognosticator.

Previous research, according to the professors, has produced conflicting views of whether emotions make for better or worse decisions. One view is that feelings introduce biases into decision-making which compromise its soundness; the other is that emotions improve decision-making by such varied means as boosting attention and memory, enhancing the ability to establish priorities, or sharpening such cognitive faculties as creativity or analysis.

While the new study does not rule out the potential of emotions to introduce irrational biases into decisions, it suggests that such biases have less to do with the intensity of feelings than with lack of clarity about them. Prof. Seo cites as an illustration the investor who performed the worst among the study's participants:

"Here was a person who consistently described his feelings as neutral or close to it" the professor says. "Based on the belief that emotions are bad for decision-making, one would suppose this emotional profile would be a plus. But this same individual proved to have little ability to differentiate among feelings, so that even slight changes in them tended to produce high-risk choices. In essence, this individual was victimized by emotions, weak though they were.

"In contrast," he adds, "the best performer in our simulation (who achieved a return of 12.7% and won our grand prize of $1,000) tended to have relatively intense feelings and also an above-average ability to differentiate among them. The emotions this person experienced during the simulation did not push him into high-risk choices."

Prof. Seo recruited participants for the study in investment clubs, with volunteers being promised remuneration of $100 to $1,000 depending on their investment success over the course of a four-week experiment. Ranging from 18 to 74 in age and averaging 4.3 years of investment experience, participants each were granted a hypothetical $10,000 that they were free to invest in any or all of 12 stocks of publicly traded companies identified only by a letter of the alphabet.

On each of 20 consecutive business days, at some time between 6 p.m. and 9 a.m., participants logged on to the experiment's Web site, where they received a summary of their investment performance to date plus detailed information about each of the 12 anonymous stocks -- its current price, daily percentage price change, average price change rate for the past five days, volatility in relation to the market, one-year performance, and price-earnings ratio, along with the size of the issuing company. Besides making investment decisions, participants were asked each day to rate on a scale of 0 (not at all) to 4 (extremely so) their current experience of 22 different feelings, both pleasant feelings (excited, enthusiastic, proud, satisfied, etc.) and unpleasant ones (irritated, afraid, frustrated, depressed, etc.)

The data enabled Profs. Seo and Barrett to analyze how greater and lesser intensities of feeling were related to investors' risk-taking propensities and their overall results. They were also able to gauge participants' differentiation among feelings by calculating the correlations among three positive affects (calm, happy, and excited) and three negative affects (sad, angry, and nervous). Thus, if participants consistently indicated that they experienced sadness, anger, and nervousness to about the same extent, they were deemed to have low negative- emotion differentiation; if they reported being calm, happy, and excited to about the same extent, they were judged to have low positive-emotion differentiation.

The professors found that the greater the average intensity of an individuals' feelings over the course of the 20 days, the higher their investment returns. In addition, the sharper participants' ability to differentiate among their feelings, particularly negative feelings, the greater the investment returns. This ability to differentiate, Seo and Barrett find, translates into what the professors call "affective influence regulation," a process "in which bias-inducing effects generally disappear or are reversed as people become aware of and actively manage their affective experience."

In other words, good decision-making arises from being able to have intense emotions and to regulate them at the same time. But somewhat like physical and mental agility, the two capacities, Seo and Barrett find, are "virtually uncorrelated"; in all likelihood, they are "mutually independent processes within an individual."

While challenging the dominant view of managers and investors that feelings are best kept out of decision-making, the professors concede that this view is "not... entirely wrong." The problem is that it "attempts to minimize the potentially negative effects of our feelings together with all the potentially positive effects, such as enhanced decision efficiency, engagement, and creativity -- thus 'throwing the baby out with the bathwater.' "

A better alternative, they write, is "to minimize the possible negative influences of affective feelings once affective experiences and expression become more encouraged and less constrained in the workplace."

The study, entitled "Being Emotional during Decision-Making -- Good or Bad? An Empirical Investigation," is in the August/September issue of the Academy of Management Journal.  This peer-reviewed publication, now in its 50th year, is published every other month by the academy, which, with about 18,000 members in more than 90 countries, is the largest organization in the world devoted to management research and teaching. The academy's other publications are the Academy of Management Review, Academy of Management Perspectives, and Academy of Management Learning and Education.

Media Coverage:
Reuters. Emotional Investors Make Better Decisions. (Thursday, September 13, 2007).
The Globe & Mail. That Poker Face May Be Hurting Your Hand. (Saturday, September 22, 2007).
The Motley Fool. Go ahead. Be emotional. (Monday, December 10, 2007).
The Wall Street Journal. How to stop your emotions from wrecking your returns. (Wednesday, December 12, 2007).
US News & World Report. Decide to Share Some Feelings. (Monday, October 15, 2007).

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