Emotions can affect even the most rational of our decisions.
We are not robots after all. As human beings, we tend to get occasionally swayed by our fluctuating emotions. But when emotional decision-making becomes a pattern, that’s when alarm bells begin to ring.
The art of making sound investment decisions is a skill that one develops over time. It has no space for emotions. But even the best of us falter and let our money decisions be guided by emotion. Maybe, it works sometimes by a stroke of luck, but it is catastrophic for your long-term financial goals.
What is emotional investing?
When you let your money decisions be guided by your fluctuating emotions rather than rationality, logic, and a sound business sense, you become an emotional investor.
Emotional investors typically react extremely to routine stock market fluctuations and base their decisions on those. They indulge in panic selling when the markets fall and resort to euphoric buying when the markets are buoyant. Both these attitudes spell a disaster for their long-term portfolio.
Reacting to stock market fluctuations is just a part of investing for a beginner. The essence of making these mistakes lies in making decisions based on irrational appeals to your emotions that evade logic.
It could be your best friend telling you how they made a particular investment that gave them huge returns. Now, as an emotional investor, you get swayed by your best friend’s story, and without bothering to do some background research, you happily invest your money into that particular asset.
Why is emotional investing dangerous?
Emotion is the enemy of investors. Making wise Investments is evidence and research-based action that has no place for emotions. Even one decision of based off feelings can wreck your entire portfolio and ruin your finances.
investing this leads to overconfidence or under-confidence; both are the enemy of a sound strategy. Emotional investors will either take too many risks or no risks. Over-confidence can result in huge losses, and the tendency to act out of fear, on the other extreme, it can lead to paralysis.
A sound strategy takes a balanced approach. Your ideal portfolio has a mix of safe assets and some moderate to high-risk assets.
A trained finance professional helps investors balance out their investments in a way that minimizes risk, and maximizes return. Using you gut, on the other hand, will have you over-reacting to short-term market conditions. While one must keep in mind the overall market trends and movements, they must steer clear of basing their decisions on daily market fluctuations.
Okay, now lets show you how to avoid emotional investing like a pro.
10 ways to avoid making emotion based investments
Most of us are vulnerable to not remaining as calm as we would like when investing. That’s why it’s important to put a system in place for controlling our emotions while we walk the path to financial success. It’s not easy, but with a bit of method and willpower, you will overcome your this.
- Figure out your long-term financial goals
Before you begin investing, you got to figure out your long-term financial goals.
Where do you want to see yourself 15-20 years from now? What are your priorities? Are you ambitious and business-oriented? Or would you rather stick to a well-paying job and then later enjoy your retirement? You must have an answer to all these questions to figure out your long-term financial goals.
These goals are like the vision document of your financial journey; they tell your overall attitude towards money and what you expect of your finances. Having a long-term financial vision keeps you on the right path, and prevents you from making impulsive decisions.
- Have a long-term investment strategy in place
The next step is to create a long-term strategy based on your long-term financial goals. It would take into account your current financial status and your risk-taking abilities.
Your long-term strategy will determine the best investment plans for you, both short-term and long-term.
Having a long-term strategy in place saves you from making unresearched decisions. Spontaneity is not something to be encouraged with these financial related decisions. Having a detailed strategy will keep your emotional reactions to market volatility in check. Once you have a stable portfolio best suited to your needs, you will be less prone to making impulsive decisions.
- Diversify your investment portfolio
Diversifying your portfolio is great for long-term wealth creation. But it’s also a great strategy to make more sound investments.
People who put all their investments in that single fund or one major stock resort to panic behavior when the markets take a downturn. In their desire to minimize loss, they hurriedly try to switch to other assets. But diversification of investment portfolio cannot be done in a jiffy.
You need to do thorough research and consider many factors. That’s why it’s best to diversify your investment portfolio well in advance. Keep a balanced mix of index funds, mutual funds, and a mix of individual stocks. Diversification will keep that fine balance between risk and safety, thus assuring you that all is well. It will keep you away from rash impulsive decision-making that could negatively impact your investments.
- Take the services of a financial expert
Investing is a skill that requires considerable expertise. People often resort to making impulsive decisions due to a lack of experience.
When you don’t have expertise in something, it’s natural that you will panic and make impulsive decisions. Therefore, you must take the advice of an investment expert. This becomes especially important when you are new to investing. Once you get going, you can manage things on your own. But when it comes to creating your strategy and drawing out your financial plan, expert advice helps.
Taking the help of an investment expert will considerably lessen your stress level. Lack of adequate knowledge about something gets us stressed out. It’s human nature. When we see or read news of the stock markets going up or down, we instantly react.
We cannot emotionally detach ourselves from these developments because we lack the necessary field expertise. Consulting a financial expert will make you feel more confident about your plan.
- Do Not base your investment decisions on the news cycle
Do not get swayed by the daily news cycle regarding the stock market. News is an extreme medium. Television news, especially, often blows things out of proportion.
While it’s good to keep a track of major market developments and trends, do not base your investment decisions on stock market news.
When you react nervously to day-to-day stock market fluctuations, that’s a sign you need to take a step back. Immediate news can often not project the long-term scenario. Therefore, basing your decisions on the news cycle would lead to uninformed and uneducated decisions.
Use news as an information resource.
How a particular investment performs in the long term depends on many factors. Be up-to-date with your research, consult a financial adviser, and try to see the larger picture. Do not make yourself emotionally vulnerable to the daily news cycle.
- Avoid checking your investment portfolio frequently
You must emotionally detach yourself from things at some point to make an informed decision. If you keep checking your portfolio daily, you will become even more vulnerable to selling or buying or selling for the wrong reason
Stop tracking your investments obsessively daily. Instead, just make a plan and stick to it. Check your portfolio once a month at max. This will keep you safe from the emotional vulnerability that comes with tracking your portfolio daily.
- Find the right balance
Making a rational and logical decision is all about finding the right balance.
Both under-confidence and over-confidence are the enemies of investing. You must find the perfect middle ground to even out these extremes.
Your strategy and portfolio ought to be balanced. Diversifying your portfolio, as elaborated earlier, is a great way to hit the right balance between risk and safety. But it’s also about your mindset. No matter how many plans you make or how perfect your strategy is, you are still going to make wrong decisions if you don’t fix your mindset.
There is no sure-shot formula for doing this. And it won’t happen overnight. But you got to train yourself to be confident about your decisions and keep yourself away from irrational levels of under-confidence or over-confidence.
- Don’t be afraid of losing
Losing is an inevitable part of any game. Every player loses sometimes. But no player enters the game with the mindset of losing.
You must approach this game with the mindset of a winner. Recognize your risk-taking ability, and strategize accordingly.
There are no 100 percent risk-free investments. If you want your money to grow, you ought to take some risks. If you are always held back by extreme fear, you are going to be able to capitalize on potential opportunities. So embrace the healthy mindset of a player. You got to play the game and give it your best shot.
- Embrace logical thinking
It’s simple. Logical thinking will prevent you from making decisions influenced by your emotions. Whenever you decide on your investment portfolio, question yourself as to whether your decision is driven by emotions or backed by rationality and logic.
It’s not possible to get rid of emotions.
No matter how intelligent you are, they will come in the way of your decisions. Therefore, you must develop the habit of coolly weighing the pros and cons of every decision you make before finalizing it.
The best way to do this is by putting systems in place wherever you can. When you go by a structured plan and have a well-defined portfolio, there is little room for subjective decision-making. Thus, you are bound to be objective and logical.
- Get rid of the herd mentality
Herd mentality is the enemy of sound decisions.
It can wreak havoc on your finances. Do not base your decisions on popular trends; just because everyone else is doing this, I might give it a try as well. Following the herd mentality is not something successful investors do. Abandoning your well-balanced portfolio to bring in sudden changes under the influence of popular opinion can be a disaster for your finances.
Herd mentality would tell you that if everyone else is investing in cryptocurrencies, you should join in too and grab your share.
Remember that following trends for the heck of it would never give you the desired results. What is your financial condition? What are your goals and priorities? Is saving for retirement important for you? Every individual is unique. You have to invest according to your unique needs instead of blindly following the crowd.
Herd mentality is the pinnacle of being a beginner. It’s driven by greed and fear and both of these are the enemies of investing. Base your decisions on factual evidence, logic, research, and the advice of a financial expert.
It is not possible to invest with 100% logic.
There is a bit of subjective emotional bias involved even in the most seemingly logical of our decisions. But you can certainly keep it in check by creating a solid system of checks and balances.
Just remember that pre-planning is the key. The more you plan out your investments in advance, the less prone you are going to be towards making impulsive moves. On the other hand, lack of a plan will make your investments go haywire.
You would want to jump into every stock you heard is doing well in the news!
Finally, you got to create a diversified portfolio so that you have a pool of safer options to fall back on in case the riskier ones don’t work out. If your portfolio is well balanced and you know you are not going to be financially ruined overnight, your emotions will be under control.