“If you cannot control your emotions, you cannot control your money”
– Warren Buffet

Most investors know that emotion affects the way in which investment decisions are made – and that greed and fear play a large role in driving investment markets. The actions of many investors are based on feelings rather than facts. They may make decisions based on a host of emotional biases that, unfortunately, undermine the chance of meeting the desired investment outcomes.

Admittedly, it is difficult to escape the influence of emotions on investment decision making, and that influence is more than likely the main reason many investors do not achieve the results they want. Crucial in overcoming this risk, is awareness of how emotions can affect decisions, which may make you a better investor in the process.

It’s what you do before a plunge that counts, not the hasty reactions that come during and after, when you have no time to think

Many investors make decisions based on emotional biases that undermine the chance of meeting their investment goals.

How does one go about avoiding ‘emotional traps?’

Financial markets without volatility would be unnatural, like an ocean without waves. Like the open ocean, the market is constantly churning and the degree of market volatility varies from small ripples, to rolling waves, to a financial crisis sized tsunami. Despite any negative connotations, volatility simply refers to a change in prices. It is normal and happens over time. It is not necessarily a cause for panic and is something that needs to be considered when investing.

Financial markets without volatility would be unnatural, like an ocean without waves

In understanding that prices of stocks and bonds will go up and down, there are things that can be achieved with that in mind. Many investors are uncomfortable with the large amplitudes swings inherent in a volatile investment and thus shun this risk – and the associated return – for less-swingy, lower-return investments. Avoiding more volatile investments simply leaves a lot of potential return on the table and may shave thousands and possibly hundreds of thousands off one’s wealth at retirement. Paradoxically, avoiding risk in long-term investing typically leads to a smaller pool of wealth, feeling far “less safe” in retirement than if one had assumed more risk along the way.

How to respond to market volatility – 

It might sound counterintuitive but during periods of market volatility, the correct course of action might be to take no action. This is difficult to do because volatility can leave investors feeling vulnerable and concerned that they have to react. That means that investors who jump ship after a ‘big wave’ may break the cardinal rule of investing by ‘selling low.’

Put some time between your impulse to act and your behaviour.”
– Brad Klontz ,Financial Psychologist

Be disciplined and stay invested

There might be many investors who have made money by seemingly timing the market correctly – in other words, predicting market movements and selling or buying shares accordingly – but it is likely that this was due more to luck than skill. For the average investor it is not only difficult to foresee market upswings and downswings, but also challenging to make decisions that are not marked by emotion.

The golden rule that it’s about time in the market and not timing the market”

We know that markets do not move up in a straight line and that volatility is inherent in equities as an asset class. Checking a portfolio too frequently can make investors more susceptible to loss aversion, since the probability of seeing a loss in a short time period is much greater than over longer time periods. As a result, investors that frequently check their portfolios tend to take a less than optimal amount of risk. True long-term investors are more willing to allocate towards risky assets because they do not care about the short-term ups and downs. Holding a portfolio for long enough increases the probability of a positive return.

A goal without a plan is just a wish

Acting on emotion may lead to irrational decisions — and difficult lessons. If you develop a sound investment game plan and stick to it, you will more than likely be in a better position to pursue financial goals. A game plan can help remove emotions from the equation, enable investors to make the most of potential market opportunities; and help preserve assets during periods of volatility.

There is unfortunately no assurance that an investment strategy will be successful but investing with a clear plan provides a higher probability of meeting your goals

Investors who are not saving for a goal and/or do not have the discipline to remain invested during the time saving for a goal, are more likely to realise the waves of volatility that occur over their period of investing

Final Word

Emotion may serve you well in your personal life, but it has no place in your investing decisions. Adhering to a sound investment plan may be one of the best ways to avoid the pitfalls set by our brains.

 

source : Moneyweb.com