Taking emotional decisions for your financial investments can prove to be highly devastating. Emotional investments are often short-term choices, which affect the long-term benefits in an adverse way. If you observe the cycle of market emotions, you will find that an investor is ruled by the sentiments of optimism, thrill, euphoria, anxiety, denial, fear, desperation, panic, capitulation, despondency, hope, relief, etc. Owing to these emotions, an investor may take decisions, which may not benefit him in the long run.
Take a simple example: When you see on television that the market condition is not favorable for investment, you may panic and start thinking about selling at a low price. In another scenario, when you realize that the price of a stock is going to rise even further, you may get excited and buy at a very high price. However, think about the consequences if things do not go as predicted. Apart from losses, you may even suffer a financial setback.
You must be able to keep your emotions away from investing decisions in order to attain your financial investment goals. Hence, it is important that you take concrete steps, which will eliminate any kind of financial investments as an emotional response. Here are a few strategies that will help you in preventing emotional investing.
Have a Strategic Financial Plan
It is important that you have a strategic financial plan ready, which can act as a driving force for your investment decisions. It should include your financial goals and means to achieve them. It is possible that your emotions will go on a roller coaster ride when you will hear alarming words, like ‘recession’, ‘slack’, ‘collapse’, etc. Also, there may be times when things, like herding, market speculation, or media hype will prompt you to take sudden financial decisions. Do not get swayed by all this, and make investments or sell assets based on such temporary changes. These short-term emotions can cause long-term problems to your financial goals. Align your investments with your financial plan for reaping benefits of good returns. It is advisable that you review the plan and update its strategies every year.
It is an effective way to avoid emotional investments. Equal amounts of dollars are invested regularly for a previously decided interval. This helps to sustain during all types of marketing conditions. For example, instead of investing $2400 in stocks or funds at once, you may contribute $200 to the holding every month. This will generate an average price for the investment over a period of one year. It immensely helps the investors to manage risks.
Investors often fall prey to what we know as ‘herd mentality’. When the word spreads that a certain stock or industry is going to perform really well, groups of investors start taking interest in it. They are even ready to buy at a higher price because they think that prices will increase further. However, we have already witnessed the problems that herding has caused in the stocks related to technology, real estate, gold, etc. Hence, avoid falling into this trap. Understand why you want to purchase a stock and have valid reasons for it.
You must always buy high-quality investments, which will perform for you in the long run. You should not go for stocks, funds, or other investments, which will not be feasible, especially in the wake of an extreme market condition, like recession or slow down. Hence, do your research thoroughly before choosing your investments.
Consult an Investment Adviser
If you have a history of taking impulsive and emotional investment decisions, it is better that you take professional help. A financial adviser can help you to take rational and accurate decisions. He can also guide you about when and where to invest. He may study your long-term financial goals and arrange to structure your portfolio accordingly. Also, he will be able to exercise control on what kind of investments you make and when you sell them according to the market conditions. He can be a great asset to help you to maintain a diversified portfolio.
Invest at the Right Time
Due to the emotions of fear and anxiety, many people like to pull out of the market when the conditions do not seem good. They abandon their investments when they hear bad news. This is okay if you have allocated assets to short-term investments or if the investments may eventually challenge the limits of your risk. However, if you wait for the right time, you will reap huge benefits on your long-term investments. In 2008, many people pulled out of the market fearing the inevitable. However, the market soon regained itself after sometime, and these people lost huge benefits. Don’t let this happen to you.
Diversify Your Investments
Warren Buffett has rightly said that we should not put all our eggs in one basket. You should reduce the risk by diversifying your investments. These investments should be distributed on the basis of intensity of risk, country, industry, etc. You may also invest in hedge funds, real estate, bonds, etc. This ensures that even if one investment does not work the way it should have, there will be others who will continue to do well.
Know and Manage Risks
It is not practically possible that an investment may be completely risk-free. You must understand about every aspect of the risk involved in your investment. You must take calculated risks in order to mitigate the probability of making losses. You can consult your adviser and tell him about the level of risk tolerance that you are comfortable with. Just because someone tells you that high risk is high gain, do not go on to invest your hard-earned money.
Equilibrize Your Portfolio
You must balance your portfolio regularly. This will help you to ensure that your investments are within your risk tolerance limit and you have a diversified asset allocation in your portfolio. It helps to strategically align your portfolio with your investment objectives. Many times, people do not sell their assets that perform well; however, this may not be financially beneficial in the long run. Bringing a balance forces you to take a practical and critical look at your portfolio without getting emotional about it.
Acknowledge Your Emotions and Isolate Them
Whenever you start getting bombarded by positive or negative emotions regarding an investment, acknowledge and isolate them. Avoid the urge to make decisions based on these emotions. Try to recollect your investment mistakes, which you may have committed in the past because of an emotional surge. Try to get to the bottom of the facts and gain knowledge whether a certain thing that you have heard about the investment is really true. If you are satisfied with the results, only then go ahead and make the financial decision.
Research the Alternatives Thoroughly
Many times, you think a stock is good because top-notch analysts on TV, print, and Internet are vouching for it. You may base your decision to buy or sell an investment based on these reports. However, it is essential that you conduct a research yourself before deciding about buying the stock. Look out for the trend that the stock in question is showing, and verify its financial documents. Do not make hasty short-term plans, which will affect your long-term financial goals.
As an investor, you should never invest more than you can afford based on ‘hot tips’ or market speculation. Also, no matter what, verify all the ‘hot tips’ before you get excited and execute. One more mistake that investors commit is that they concentrate on interest rates, inflation, market conditions, natural disasters, etc., for taking an emotionally driven financial decision. However, they should rather concentrate on things, which are within the scope of their control, like allocation of assets, diversification, expenses, etc., for making their investments work. Now that you know how to avoid emotional investing, don’t let your emotions become detrimental to your financial gains.