Evidence Based Investing 101: Managing Your Emotions
EBI: Managing Your Emotions and Avoiding Reactive Investing
Investing can prove to be an emotional rollercoaster. Many investors find it challenging to separate their emotions while investing because as markets go up and down, oftentimes they make impulsive decisions with their money. Human nature can be an impediment to successful investing, as well as other areas of our lives. To be a successful investor, we need to manage ourselves as tightly as our investments and not let our emotions get the best of us.
Evolution has hard-wired the human brain to be particularly poor at making investment decisions. A deep seated sub-conscious battle between greed and desire for reward, and the fear of uncertainty, loss and social isolation, creates on-going anxiety and irrational decision-making. If this is not managed correctly, then it could lead to a loss of wealth as well as missed opportunities.
However, every individual is different and so, the balance between logical decision making and emotion can differ based on their circumstances. Studies around behavioural finance have found that investors will feel around twice the amount of pain from loss when compared to the pleasure they experience when they make gains.
This is mainly down to evolution because humans are more sensitive to losses than the appreciation that comes with gains. While it would have been good to be a species that does not recognise pain and only recognises pleasure, there are benefits to our hard-wiring as it has enabled us to evolve and set us up well for survival.
Although every person is different, many people find themselves in the middle of a battle between reflection and forward-thinking. For investors, this proves unfortunate because forward-thinking wins on many occasions and that means that panic and elation are felt as the markets rise and fall. Should the forward-thinking mind take control when making investments, then they are at risk of causing damage to their wealth because they will make decisions when they are experiencing a state of elation and greed before selling out at a low as they panic.
Understanding that investors and advisers experience a range of behavioural biases that can lead to a reduction in wealth, it pays to have investment processes in place that are disciplined, systematic and understandable. As this is implemented, it proves central to their success.
THE IMPORTANCE OF PERSONAL AWARENESS
It’s also critical that investors understand what rational and disciplined investors earn when compared with investors who are emotional and irrational. To ensure that someone’s financial and emotional journey is more fruitful, it can help to manage expectations through the right financial advice and guidance that aligns with their risk tolerance. This means that investors should have a clear understanding of their journey and understand that it is not always a case of moving forward but also taking steps back where necessary. They have to be aware that when this happens, it shouldn’t be a surprise but a part of the process, preventing them from making any snap decisions. Therefore, they should understand the benefits that come from being disciplined at times when the market is volatile.
When investors are aware of our deep thinking and how that can destroy wealth, it enables them to understand the importance of a disciplined investment process that is systematic and unemotional. So, by focusing on ourselves, we can become better investors by making controlled decisions.
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