Don't let emotions affect your investment decisions

Even the most experienced investors aren’t immune to emotional influences. In fact, fear and overconfidence frequently cloud our investment decisions, often leading to poor outcomes.

PAUL RICHARDS from Better Decisions explains that emotions evolved to keep us safe — but they don’t help much when it comes to modern investment decisions. Fear can drive us to sell at the wrong time, just as hope and greed might encourage excessive risk.

The challenge is learning to spot when emotion is interfering with our investment decisions and having a process in place to respond rationally.

KEY TAKEAWAYS

1. Don’t act when you’re tired or emotional

Making decisions when you’re anxious, tired or stressed usually leads to suboptimal outcomes. Give yourself time to reflect before taking action.

2. Seek an outside perspective

A financial adviser or even a trusted family member can offer a valuable second opinion and help you think more clearly.

3. Stick to your plan

Having a clear long-term investment plan can help you stay grounded and reduce the impact of short-term emotional reactions.

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https://www.evidenceinvestor.com/post/lessons-in-life-and-investing-from-shane-parrish 

https://www.evidenceinvestor.com/post/should-you-put-off-investing-amid-uncertainty 

https://www.evidenceinvestor.com/post/three-big-investing-mistakes-to-avoid 

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TRANSCRIPT

Robin Powell: As investors, most of us would like to think we make rational decisions. 

The truth is, our emotions often play an important part.

Humans have evolved to experience emotions to help us survive

Fear, for example, is such a powerful emotion that it’s almost impossible to ignore.

Paul Richards: The big challenge that we have is that we still carry over all these behavioural mechanisms to how we actually invest. 

So, for example, if we see some bad news in the economy or in the market, or perhaps our investment portfolio has dropped a little bit, we feel fear, we feel anxiety. And that signals to us that maybe we should be doing something. 

Should we be taking our money out of the market? Should we be moving it into lower risk investments? 

And the key problem here is that all the emotions, for example, like fear that we've built to deal with danger. We've got a hair trigger. 

It was always far better in our evolutionary past to jump up, even if there was no tiger in the trees. 

The problem is now, every time markets go down a little bit, we can feel the tiger in the trees and feel compelled to act. 

RP: While fear and anxiety make investors want to sell, other emotions encourage them to buy.

Desire, hope and greed, for example, all make us more inclined to increase the risk we’re taking.

PR: When we want something, when we really want something, then it can short circuit, rationality. 

It means that we suddenly stop looking for important things. We stop looking for those signs that things might be going wrong. We become blinded by it. So these emotions can really help us. 

They can move us towards or away things cool and rational decision making is often probably better for the type of decisions that investors have to make today. 

RP: Curbing your emotions isn’t easy. But, for Paul Richards, there are three key things investors can do.

PR: I think the first and most important thing is just to recognize that we shouldn't make decisions when we're feeling highly emotional or tired. We're rarely going to get to a good outcome. 

And sometimes, perhaps if we're on the battlefield or if we're a surgeon doing an operation on someone, we have to make a decision right now to get to a good outcome. 

But if we're a private investor working with a financial advisor, we rarely have to make that choice. 

If we are feeling tired or stressed, we should just do what we'd recommend to our children to go to bed, sleep on it, and see how you feel in the morning. I suspect 99 times out of 100 we'll get to a better answer from that. 

The second thing that we can do is have someone who's outside of the process giving us some advice. 

Now, like most typically, the second thing that we can do is have someone who's outside of us giving us some advice. Usually this can be a financial advisor, but it can be a family member. For example, I know I am a pretty regretful decision maker. 

I've made my wife aware of that. So when we sit down and make decisions, she can remind me that she can actually provide some balance. The last thing is just have a sensible long term plan. 

The whole thing with emotions and decision making is they just pull us from pillar to post. 

If we have a very clear idea of what we're trying to do, when we're trying to do it by and how we're going to do it, we've always got a benchmark where we can ask ourselves, does this decision take me to where I need to be or not? 

If we can do those three things which are simple, easy and effective, then I think most of us will get better outcomes. 

RP: It’s totally unrealistic for investors to avoid feeling these natural emotions altogether.

But you should at least try to recognize them. 

Admitting your emotional foibles to yourself, and to your financial adviser, is a crucial first step.