Don’t let your emotions get in the way of smart investing

It’s often said that the share market is driven by two emotions – fear and greed. While this might be an over simplification, it helps to explain investor behaviour and why so many people are unsuccessful at investing.

Emotional investing refers to the way in which investors have a tendency to make investment decisions based on how they feel about the market at a particular point in time. If the market is low, investors typically feel dejected, and when the market is high, they feel ecstatic.

Poor investment behaviour is typically driven by a fear of loss, or overconfidence. During rising markets, investors may become over confident and assume that the good times will continue into the future. This tempts some investors to pour more money into the market when the costs of entry are high.  This can create over-inflated markets and stock bubbles which will inevitably burst at some point.

Just as markets can become overheated with greed, they can also collapse through fear. When markets suffer large losses over a sustained period of time, investors can become fearful of incurring further losses and may rush to exit the market when stock prices are falling.

Unsurprisingly, buying when share prices are high and selling when they are low is a recipe for disaster.

By contrast, successful investors generally have a disciplined approach to investing and tend to succeed when they stick to, and make decisions based on, their investment decision-making process.

The key is to avoid getting swept up in the dominant market sentiment of the day which is typically driven by fear and greed, aided and abetted by the 24 hour news cycle. The media supplies an incredible amount of information on a constant basis often prompting investors to make emotional decisions based on the news of the day rather than what’s in their long term best interests.

The investor who attempts to time the market – hoping to make quick gains by buying low and selling high – is most likely guided by emotion and more likely to fail than an investor with a longer term perspective. Mature investors understand that volatility is a natural part of investing in the share market and they learn to ignore the day-to-day ‘noise’ of industry commentators.

Attempting to time the market is a road fraught with failure.  While it is possible to understand overall trends and market movements, knowing when to buy or sell at precisely the right time is very difficult. You may well turn to the experts in the media for advice on market timing, but the reality is they don’t know the answer either.

Remember no one can predict whether the market will rise or fall, however you do have control over the amount of time you spend invested in the market. Generally, the longer you are invested, the more likely you are to be successful.

As an investor, it is important to recognise the symptoms of the emotional investing trap and to avoid making decisions based on the ‘herd’ behaviour of others.   It can be challenging to remove the emotion from investing, especially during times of market volatility when all others around you are losing their heads, but there are some key steps you can take to ignore the noise and remain focused on your long term investment goals.

Key ways to remove the emotion from investing

Develop a detailed long term plan. Investing is a long term strategy that requires careful planning. Your investment strategy should involve a detailed plan with specific goals. Your financial adviser can provide invaluable advice in developing a well-structured, diversified investment portfolio that’s tailored to your needs, your circumstances, and what financial advisers call your ‘risk profile’ or tolerance towards risk.

Learn to ignore the noise. Sensational headlines and day-to-day share market commentary from economists and reporters may well keep the media and those commentators in business but they only serve as an unnecessary distraction from achieving your long term investment goals.

Avoid the herd.  It’s a natural human tendency to follow the behaviour of large groups. However just because everyone else is jumping on a particular investment bandwagon it doesn’t necessarily mean that it’s a smart strategy or one that’s right for you. In fact, investments favoured by the herd run the risk of becoming overvalued as the investment’s initial appeal may well be based on optimism rather than legitimate underlying fundamentals. As the renowned investor Warren Buffett once said “Be fearful when others are greedy, and be greedy when others are fearful.”

Adopt a disciplined approach to investing. Stick to the plan. You are more likely to be successful if you invest a fixed amount of money on a regular basis, regardless of whether the share market is up or down, rather than investing ad hoc amounts based on emotional speculation about future market movements.

Investing over the long term is one of the key ways to grow your wealth however it is not without risk. As always, we recommend seeking professional advice before making a decision.

If you’re considering investing in the future, or if you wish to review your existing portfolio, please contact us for assistance.

Source: Capstone