How to avoid emotional decision-making when it comes to investments

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BUSINESS NEWS AND VIDEO - 2024 is not just any election year. It can perhaps be seen as the election year.

Globally, more voters than ever in history will head to the polls as at least 60 countries, representing an almost 50% of the world’s population, are holding national elections. Typically, emotions run high in elections years.

Basic investment principles
Emotional investing refers to making investment decisions based on emotions such as fear, greed, or panic rather than objective data.

Letting emotions have an influence can be one of the biggest risks when making investment decisions, and to achieving your long-term investment goals, as often such decisions result in sub-optimal outcomes.

As an investor or investment manager, it’s essential to avoid making investment decisions based on emotions.

Examples of emotional investment decisions

Reacting to short-term market fluctuations
Emotional investors may become overly focused on the daily or weekly performance of the market and make impulsive investment decisions based on short-term market movements.

Dramatic short-term market losses can feel painful, but it’s important to keep a long-term perspective, stay invested and then benefit from the recovery that usually follows. While some bear markets have seen sharp downturns, many recoveries or bull markets (market increases) have been even sharper and have lasted longer.

Trying to time these downturns and upswings is guesswork and can lead to permanent losses in capital, and the best advice is to stay the course, stick to your long-term plan and ignore the inevitable negative noise that comes from the media during these times.

Ignoring fundamental investment principles
Another type of emotional investing is ignoring fundamental investment principles. Emotional investors may overlook important investment factors such as risk tolerance, asset allocation, and diversification, and instead make investment decisions based on rumours or hype.

Focusing on a single investment
Emotional investors may also have a lack of diversification in their portfolio. They may become overly focused on a particular stock or sector, which can increase risk if that stock or sector experiences a downturn. By diversifying their portfolio across different asset classes and sectors, investors can reduce their risk and potentially improve their investment performance over time.

Following the crowd
Emotional investors may follow the crowd and make investment decisions based on what others are doing. For example, if everyone is buying a particular stock, an emotional investor may feel compelled to buy it too, even if it doesn’t align with their long-term investment plan.

Steps that help to avoid emotional decision-making

Develop a long-term investment plan
One of the best ways to avoid emotional investing is to develop a long-term investment plan. This plan should consider your goals, risk tolerance and time horizon. By creating a plan, you’ll be less likely to make impulsive decisions based on short-term market fluctuations. Instead, you can focus on your long-term goals and stick to your investment plan even during times of market volatility.

Stick to your investment plan
Once you have developed a long-term investment plan, it’s important to stick to it. During times of market volatility, it can be tempting to make impulsive decisions based on emotions. However, it’s important to remember that investing is a long-term game. If you’ve developed a solid investment plan based on your goals and risk tolerance, you should stick to it even during periods of market volatility.

Avoid speculative investments
Another way to avoid emotional investing is to avoid speculative investments. Speculative investments are investments that, although they may have a high perceived pay-off, are also very risky and are often based on rumours rather than sound fundamentals. While these investments may have the potential for high returns, they can also incur significant losses if the investment does not perform as expected. Therefore, investors should limit their exposure to such investments to what they can reasonably afford to lose.

Work with a financial adviser and diversification remains a key component
Most investment professionals agree that, although it does not provide a guarantee against loss, diversification is a key strategy when it comes to achieving long-term financial goals and minimising risk. Having adequate exposure to both local and global markets and other asset classes such as bonds and cash, remains the key ingredient for achieving investment goals.

A financial adviser can provide you with objective advice and help you make informed investment decisions. This will also help you develop a long-term investment plan that aligns with your goals and risk tolerance.