Investing without emotion
Written by Carl Turner on July 03, 2014.
It is a normal human response to react emotionally when investing but studies suggest that feelings of euphoria at a significant financial gain, or fear of a loss, cause investors to make poor investment decisions. The emotions that tend to drive most investors lead them to a “Buy high, sell low” mentality which is fatal to a successful investment portfolio, reducing potential returns.
To paraphrase none other than über-investor, Warren Buffet, a man whose advice is probably worth taking when it comes to investment, if you were hoping to buy a car in the near future, would you be pleased or disappointed if the price of cars were to rise? The answer is obvious – you wouldn't be.
As a general consumer, it would be completely irrational to hope for something to rise in price just before you are about to buy it and yet that is exactly what many investors do. Often shareholders celebrate stock prices rising although if they are buying stock on a regular basis, they are in effect rejoicing at a rise in price of something they are about to buy. Prospective investors should in fact, be pleased that prices are falling. Rising stock prices are only reason for celebration for anyone planning to sell in the near future.
In reality, individual investors often miss the boat when share prices peak because by the time they have picked up on the fact that a particular stock is strong, either via the mainstream media or from friends, family or colleagues, the ship has sailed on that particular investment as it will already be back on a downward trend and any investment will subsequently diminish in value. Similarly, fear of financial loss when their shares are losing value leads many investors to sell right at the bottom of the market, missing an opportunity as the market rebounds.
In order to keep emotion out of your investment decisions, you should follow some key principles. The first of these is to be in it for the long haul. Warren Buffet may well respond to the daily market fluctuations of share values but for the individual small-time investor that is a strategy best left to the experts. What really matters to most investors is returns over a long period so focus on the bigger picture by setting your financial goals, choosing your investments wisely and sticking to your long-term game plan.
On the subject of choosing your investments wisely, make sure that your investment portfolio reflects your attitude to risk. If you wouldn’t dream of risking a $100 bet on the horses, you definitely shouldn’t be taking a high risk strategy in your investment portfolio if you want to be able to sleep at night. In reality most of us are not big risk takers when it comes to money. As well as denying you sleep, worrying about the falling price of your shares may cause you to make ill-advised decisions so be honest with yourself about the amount of risk you are willing to take with your portfolio and invest accordingly.
A well-managed and diversified investment portfolio can help you stick to your long-term goals without getting side-tracked by the daily ups and downs of the market. Your investments should be actively realigned depending on market conditions but review them quarterly or monthly rather than daily so that you can remain distant from temporary volatile market swings.
Having a financial advisor by your side can be invaluable to help you stick to these key principles. They can act as the voice of reason when you are swayed by the ups and downs of the market and sensationalist media coverage and will keep you on track to meet your long term financial goals.