Warren Buffett once said, “the most important quality for an investor is temperament, not intellect”.
In other words, being able to remain calm and hold investments, even in times of turmoil, is often more important than analysing investments and trying to time the market. However, many investors struggle with this notion.
According to FTAdviser, financial advisers report that emotion-driven decisions are costing their clients an estimated 2% of their returns each year.
Fortunately, if you have a clear, goals-based strategy in place and you can resist panic during market fluctuations, you may be able to keep the emotion out of your investment decisions.
Read on to learn why so many of us let emotions get in the way in the first place, and how you can potentially avoid it.
47% of advisers believe their clients are “too influenced by the news”
Often, emotion-led decision-making is worse during an economic downturn because you may feel that your wealth is at risk and you need to take action to protect it.
The 24-hour news cycle, full of stories about high inflation or dropping share prices, fuels this feeling and many investors may decide to change their strategy to avoid losses.
Unfortunately, this can often lead to irrational decisions led by fear and short-term thinking, rather than a long-term financial plan. Advisers see this often and, as reported in FTAdviser, 47% believe that their clients are too influenced by the news.
Additionally, 63% of advisers say they are regularly surprised by the suggestions clients make about their investments – likely because they are rushed and have not properly considered the risks or the consequences.
It’s not just bad news that encourages poor investment decisions either. You may hear news about the next big investment tip, or a new startup that is guaranteed to be a huge success, and let excitement get the better of you.
However, rushing into such investments may not be the best idea because nobody can see the future. And even if those predictions are correct, the investments may not necessarily align with your own personal goals and attitude to risk.
That’s why it is normally a good idea to create your own unique financial plan and follow it, without letting the news influence you and push you towards emotion-led decisions.
But we’re all human and it can be difficult to resist the urge to react, especially when you see the value of your investments dropping. Fortunately, if you are concerned about your emotions getting in the way of your investments, there are some effective ways to potentially avoid it.
5 ways to avoid emotion-led investing
- Think long-term
Selling investments because of a temporary dip in the market is a prime example of short-term thinking. You are attempting to avoid short-term losses, but you are not considering your long-term goals, or the potential future gains you may be missing out on by selling the investment.
It may be better to take a long-term approach because holding an investment over a long period of time may increase your chances of positive returns. Even after big fluctuations, markets tend to correct themselves so you may well regain any short-term losses.
According to Investopedia, the majority of people investing in the S&P 500 for a period of 20 years or more since the 1920s would see positive returns. This is true even when you consider market upsets like the Great Depression, the dot-com bubble, and the 2008 financial crisis.
You may want to remind yourself of this when you feel panicked and tempted to make reactive decisions instead of thinking long-term.
- Stop listening to the news
You may think that listening to the news can help you predict market movements or find great investment tips that can help you to increase your returns.
However, predictions about investments are often wrong and the people making them may not be qualified to give you advice. If you jump on the bandwagon and invest based on the advice of others, or the predicted effects of world events, you may experience significant losses.
It’s also easy to let the warnings of others convince you to sell investments that would have performed well in the future.
So, you may want to ignore the news and focus on your own financial plan instead of trying to predict the future.
- Diversify your investments
Diversifying your investments can be an effective way to protect your wealth. Even if you experience losses on some investments, positive returns from other investments may balance that dip.
However, if you put all your eggs in one basket, you may not have this protection. So, while there are no guarantees about performance and you cannot entirely remove the risk, having a diversified portfolio may protect you to some extent.
Hopefully, this gives you some peace of mind when your investments temporarily drop in value, so it is easier to remain calm and avoid emotional decisions.
- Use pound cost averaging
Pound cost averaging involves “drip feeding” monthly contributions to your investments instead of investing a lump sum. The same principle applies to investing lump sums over a number of months rather than all at once.
The rationale behind this is that it can average out the cost of buying stocks and shares, or units in a fund, for example, because you are buying them for different prices each month as the value changes.
This may smooth out the market fluctuations and reduce the risk caused by the market plummeting shortly after you invest the money. Instead of making losses on one large lump sum, you only see losses on the small portion invested that month.
Additionally, you may be able to invest for less in certain months, particularly after a big dip in the market, meaning you could see higher returns if the value of the investment increases.
While there are no guarantees and the overall value of your investment could still drop, pound cost averaging may help to protect against the large peaks and troughs that often cause panic and lead to emotion-led decisions.
However, it is important to note that this strategy requires you to hold more of your wealth in cash savings as you only invest a small amount each month. During periods of high inflation, your cash will lose value in real terms, so you may need to consider this when deciding if pound cost averaging is the right option for you.
- Work with a financial adviser
Working with a financial adviser can be an excellent way to ensure you make measured decisions about your investments.
Before you make any changes to your financial plan, you can discuss it with us first and we will help you properly balance the risks. Ultimately, this means you can make informed decisions with your wealth.
Perhaps more importantly, we can offer you reassurance when you are concerned about your financial plan, and help you stay on track instead of making rash decisions.
Get in touch
Emotion-led investing can derail your financial plan, but working with your Flying Colours financial adviser can help you stay focused.
Email hello@fcadvice.co.uk or call 0330 828 4714 for more information.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
