Three Emotions to Avoid and Three Ways to Protect Against Them When Investing
- September 25, 2023
Emotion is one of the biggest enemies of successful investing. Managing your emotion in difficult and choppy markets can be hard. A 2018 study published in the Journal of Financial Planning found that investors who use a behavior modified approach to investing that removed emotion saw returns up to 23% higher over 10 years.1
Removing emotion means not making decisions based on the emotions we feel when the stock markets are going up and down. How can you combat emotional investing? Resist herd psychology. We know that fundamentally we should buy low and sell high. This might mean you are buying when the herd is selling. Warren Buffet said, “Be fearful when others are greedy and be greedy when others are fearful.”
There are primarily three emotions that can negatively affect sound investing decisions:
- In a study by Dalbar in 2018, the S&P500 lost 4.4%. But the financial analytics firm found that the average investor in 2018 lost 9.4%.2 The average investor lost double due mostly to panic selling.
- Too many would-be investors sit on the sidelines in the early stages of market upturns out of fear and then start seeing dollars signs as they watch the stock market climb. Our emotion typically tells us to sell when stocks are down and buy when stocks are up. That is not an emotional trap we want to fall into.
- Impatience can get in the way. It can make us want to dump fundamentally sound investments just because you get tired of waiting for them to show progress. Overreacting to frustration can often rob you of your best investments and ideas.
These emotions are big enemies of investors especially in choppy markets. How do you protect yourself against that emotion?
- Understand fundamentally that when you invest in the market, it should be with a longer term view. The long-term view in terms of investing is a minimum of five years. We should be looking at rolling five-to-seven-year periods as you are getting closer to retirement, whereas a ten-to-twenty-year view is more common when you are in our younger investment years and can let our investments roll with the ups and downs of the market.
- One of the keys to making money in the stock market is to stay invested. It’s your time in the market, and not your timing of the market. One of the ways to ensure your time in the market is to have an income plan that allows you to draw your income from investments that are not in the stock market. When markets are inevitably down, you have time on your side to wait for recovery.
- You do want to look for opportunities in choppy markets and also protect yourself from unnecessary risks.
With a good plan that includes both a short- and long-term view, you can try to eliminate the effect of human emotion on your investment success.