Why Emotions Have No Place in Investing
Emotions dictate our lives. They’re responsible for our highest highs, our lowest lows, and just about everything in between.
Emotions are extremely valuable, too. They can help to keep us on the right course and make fulfilling decisions when we’re facing a fork in the road. However, they can also wreak havoc when a situation calls for logic and reason as opposed to acts of emotion.
Investing is one such scenario. Emotional investing almost always results in a loss – and here's why.
Emotions Can Negatively Impact Investment Decisions
We’ve all heard it a thousand times: the stock market is volatile. However even though we know this to be true, it doesn’t make it any less intimidating when a portfolio’s performance starts to look like a sine wave.
Fear and excitement are the two main emotions felt by investors. Fear comes into play when the market is down and investments are in the red, and this fear causes investors to panic and sell assets for a loss. When investments are soaring, on the other hand, emotional investors have a tendency to get excited when they see their portfolio (or a particular asset) grow and this excitement leads them to make purchases that they wouldn’t have otherwise made.
This is all understandable, yet it’s not practical. This cycle essentially translates to an investor buying high and selling low, which goes directly against savvy investment tactics.
Emotions unrelated to the performance of the market can have an impact on an investor’s decision making as well. If a friend or colleague won’t stop raving about a stock that, in their opinion, is “about to skyrocket,” this can lead to that excitement that causes an investor to purchase without doing their own research.
Conversely, if a personal emergency or event causes panic and chaos in an investor’s life, this might prompt them to sell their assets earlier than anticipated rather than waiting for the right time. (Life happens sometimes, and that’s unavoidable. However, establishing a solid emergency fund can counteract this panic and avoid unexpected life events from affecting an investor’s assets – read our article on How to Make a Budget to learn more).
Account for Emotion When Building Your Portfolio
Different people manage their emotions in different ways – this is perfectly acceptable, and to be expected. By simply being aware of how emotions influence your decisions and how you interact with your emotional responses, you can set out to manage your investment portfolio in a way that is conducive to both the way you function and achieving your financial goals.
Risk tolerance in particular is an important factor which will dictate your investment style and account for the emotional ups and downs that come with investing. If you know that you do poorly when faced with stress or temporary losses, for example, to the point where those dips could cause you to make short-sighted and ultimately costly decisions, you might want to consider an investment style that minimizes those stresses and reduces the likelihood of emotional investing decisions down the road.
Not sure how your emotions and preconceived notions might impact your investments? Take our Investor Bias Quiz to find out.
Ride the Waves with Dollar-Cost Averaging
With self-awareness and an understanding of the market’s natural fluctuations, you can approach investing with a level head and a clear plan. One of the simplest and most common methods of doing so is to employ the dollar-cost averaging technique.
Dollar-cost averaging involves investing equal amounts of money at regular intervals, regardless of the price of a stock. As the market fluctuates and stock prices go up and down, this technique has been proven to work effectively and take the emotion out of investment decisions. While sometimes dollar-cost averaging will lead to slightly overpriced purchases when the market is up, it will also allow you to buy stocks at a discount when the market is down.
Employing a technique like this is a great idea if you’re prone to worrying or making emotional decisions. This takes the thought and emotion out of it – all you need to do is research an asset and determine whether or not it’s one you’d like to buy, and from that point on the decisions are made for you. Sticking to the plan allows you to sit back and watch prices rise again after they’ve dipped and vice-versa, preventing any emotional decision-making and financial losses in the process.
Consult a Professional
Investing can be intimidating. When it comes to something as important as personal finance, it makes sense to be a little bit uneasy if you’re just getting started.
For new investors and experienced ones alike, it’s always good practice to consult a professional financial advisor for guidance regarding your investment portfolio and techniques. This will allow you to confidently make the right decisions to help grow your worth and reach your long-term financial goals, whatever they may be.
The WealthTrack team has the extensive experience needed to help you navigate the investment landscape and make decisions that align with your particular risk tolerance. Book a discovery call to get started today!
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