This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Investing in shares, bonds and property can be rewarding – but also involves risk. How do you know what the value of your investment will be in the future? This uncertainty brings a lot of powerful human emotions into the equation like fear, excitement, apathy and overconfidence. Without careful management, your emotions can lead you to make impulsive decisions that you may regret later – e.g. selling an investment out of fear of further price falls, only to miss out if the price unexpectedly rebounds.
Below, our team at Elmfield Financial Planning in Padiham, Burnley offers 4 tips to help identify and manage investor emotions effectively. We hope this is useful and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
#1 Understand the Investor Emotion Cycle
Broadly, investors often experience four stages of emotion when watching their portfolio go up and down. Firstly, they may feel reluctance as they enter the market (e.g. committing capital to a fund) and worry about making a mistake. Secondly, investors can then feel greater optimism and even excitement if their investment rises in value. If this “bull run” goes on for long enough, it can lead to overconfidence and misplaced optimism. Possibly, the investor puts even more money into their investment to try and benefit more from the rise.
Almost inevitably, of course, the third stage shows the investor starting to experience denial, fear and panic as he/she watches the investment price fall. At this point, the investor may start “panic selling” to try and crystallise some gains – or minimise further losses. Eventually, at stage four, the investor may experience depression, apathy and (eventually) reluctance again as they nurse the wounds of the whole stressful experience.
Of course, the investor’s emotional journey does not always look like this. However, recognising the different emotions commonly involved in various price movements can help you take a step back and look more objectively at your investment. If you feel good due to the price rising, does that justify putting in more capital? If you feel unhappy because the price is falling, conversely, is this a sufficient reason to sell the investment?
#2 Remember that nothing is risk-free
It can be tempting for investors to crave the “safety” of cash. However, whilst cash will not go up and down like stock market prices, it is not a risk-free asset class. In particular, inflation is likely to erode the real value of cash over time (since interest rates from regular savings accounts rarely keep up). Also, you face a currency risk when buying goods – or moving money – abroad due to fluctuating exchange rates. This can help you keep a cool head when stock markets are volatile and you may wish to move more wealth into cash. Remember, each asset class has its own risks and potential rewards. A savvy investor will not seek to flee risk entirely, but rather try to manage and mitigate it.
#3 Take a long-term view
Many investment scams are marketed as a “get rich quick” scheme, offering “guaranteed” high returns within a short space of time. Legitimate investments such as bonds and publicly-traded stocks, however, tend to take years to produce a return (e.g. 5+ years). Along the way, you are also likely to see your equity investments fluctuate in value. Consider the S&P 500, which tracks the 500 largest publicly traded in the USA. Since its inception in 1957 inception to end of 2021, it has produced an average yearly return of 11.88%. Within that timeframe, however, many “bear markets” and “shocks” have occurred, often leading to short-term losses. Yet those who have taken a long-term view to investing in indexes like these have often reaped rewards decades down the road.
#4 Have a system and stick to it
Many people have a moral philosophy which helps to guide their choices through life, helping to answer important questions such as “Who do I marry?” or “Which job should I accept?” When investing, it can also help to have a belief system which can help “anchor” your thinking during times of high emotions. Warren Buffett, for instance, largely adheres to the philosophy of value investing which involves looking for “bargain stocks” with great business fundamentals. Here, he assumes that the market should, eventually, recognise the true value of these stocks and draw more investment – pushing up the stock price.
The primary alternative to value investing is growth investing, which tries to select investments which are exhibiting exceptionally-high profits, revenue or cash flow. Others subscribe to an evidence-based investing approach, which tends to emphasise selecting high-quality “passive” index funds over actively-managed ones (which often involve high fees and do not necessarily outperform the former) when building an investment portfolio. Regardless of your philosophical choice, having a clear mental framework for investing means that your decisions do not have to be driven primarily by “gut feeling” – but rather by sound principles.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
