If you’re thinking about investing for the first time, there’s probably some underlying reason driving you into action. Maybe you’re looking to save for a house, or to travel the world, or maybe you’re just looking to gain some financial independence. So, when you’re told to leave your emotions behind when making investing decisions, it probably seems more easily said than done.
The truth is; however, that bringing emotions to the table when making investing decisions is just as unwise as letting yourself get emotionally attached to a single Game of Thrones character – there’s always a possibility that it won’t end well and that you’ll spend the better part of a year scouring the internet for resurrection theories. With investing, decisions should be rational and follow a set strategy, otherwise, you may make an impulsive decision that could hurt you in the long run and cause you to be fearful of continuing.
What Drives Emotional Responses to Investing?
We get it, you’re in the business of trying to grow your hard- earned money. It’s easy to react impulsively to any dip or climb in the market. During times of stress, euphoria, or fear, you can fall victim to your own emotions and fail to adhere to your original investing strategy.
Historical trends demonstrate that, most often, investors act to protect themselves from losses at all costs and to capitalize on potential gains. Essentially, investors are driven to act by fear and greed, which can often lead them to overreact to short-term market movements.
Why Can Acting on Emotions be Detrimental to Investing?
Being motivated by fear and greed can often cause investors to avoid taking necessary risks or to take on too much risk. For example, a dip in the share price of an investment may cause some individuals to sell their shares too quickly. Conversely, a rise in share prices may cause some to blindly buy up shares.
When reacting to price fluctuations, keep in mind that by the time the news of a downturn or upswing in the markets is released by the media, the news is often outdated. This often causes many investors to buy high and sell low.
A study conducted by DALBAR showed that, although the S&P 500 saw an average annual return of 8.4% from 1989 to 2008, investors saw an average return of only 1.9%. This suggests that investors often sell their positions after the market hits bottom and buy into positions after the market as already peaked.
How Can You Prevent Emotions from Impacting Your Investing?
The best way to prevent your emotions from dictating your investing strategy is to try and not react to market movements. When you see that the market is experiencing a lot of volatility, take a deep breath before springing into action. If the share price of a stock you’re invested in drops, but the fundamental reasons that you invested in the company still hold true, you should likely keep your position.
Another strategy that can help you remove your feelings from investing is dollar-cost averaging. This basically means that you invest a set dollar amount into your portfolio at regular time intervals (every week, moth, etc.), regardless of share price. With dollar-cost averaging, you’ll buy more shares when prices are low and fewer shares when prices are high and, eventually, the average cost per share will decrease. Dollar-cost averaging lessens your investing risk because you aren’t seeking to time the market by putting all your money into an investment at a single point in time. In addition, utilizing dollar-cost averaging will help you commit to saving and investing regularly which can help take the emotions out of your decision making.
The fractional share technology on DriveWealth’s app makes it easy for investors to take advantage of dollar-cost averaging in their investing. Fractional shares allow investors to put any dollar amount they want (even just $5) into any stock they want, regardless of share price. Having the ability to invest in dollar terms can allow you to refrain from making decisions based on movements in share price alone.
As you start your investing strategy, remember to diversify. This means that you should invest in companies that span various industries, asset classes, and geographic locations. Historically speaking, these subsections of the market rarely move in exact unison. The idea here is that if one of your investments takes a hit, your overall portfolio will be protected by your other investments.
As difficult as it may seem, try to keep a level head when monitoring your portfolio and making new investments. Just remember, all that angst and depression you felt immediately following the Red Wedding is probably completely gone now that you’ve stuck with the show and seen that other characters have taken up the main arc of the story. The same holds true for investing. If you stay true to your investing strategy, you’re more likely to grow you portfolio over time.