As you may already be aware, many of my articles are about investments; how much you should invest and what you should invest in. I’ve even brushed on a little bit how you can be a disciplined investor. Today I want to delve further into this topic…how to take emotion out of investing. This may seem like a simple thing to do but, when money is involved, feelings are bound to get hurt.
A CFA Institute study showed that over a 30-year period, the average US equity investor achieved a return of 3.8% per year. But, surprisingly, the S&P 500 gave 11.1% returns. What’s the reason for the huge difference? Why did people not reap the full rewards? The answer is very simple…bad timing of the market.
Emotional investing is a bad strategy that I would not advise to anyone. Many people panic if the media hypes up a stock, or predicts that a market will crash. This is almost a self-fulfilling prophecy. If anyone remembers about Y2K, or has read up on the Dot-Com Bubble, you will know that the media told everyone that computers would crash (due to the computers thinking the year ‘00’ would mean ‘1990’) and that everyone’s bank accounts would be wiped when the servers had this tech error. Of course, this didn’t happen. But the media phrenzy caused stocks to plummet, and when there were so many web giants, we were only left with a few, like Google, Apple and Amazon. Playing into this fear caused thousands and thousands of people to lose their money on the stocks they had.
Fear is very often the driving force behind bad investing, and its co-pilot is greed. These two emotions can cause investors to buy at a high price (in hope it will go higher) and sell low (panicking that it won’t go back up). This clearly is not going to be fruitful or give you decent returns in the long run, so how can you avoid this?
There are two key ways to take the emotion out of investing and think rationally with your investing. The first is diversification. This is a word I have mentioned a lot in previous articles. Diversification is the investment strategy of buying an array of investment types; stocks, bonds, buying equities in different countries, different industries and just generally not putting all your eggs in one basket. There are only a handful of times in human history, when all markets have moved up or down in unison, so this method provides a buffer against volatility. Because one investment’s losses are offset by another’s gains, your portfolio will survive long term.
The next method to remove emotion from investing is dollar-cost averaging. I have also mentioned this several times before in previous articles. This idea is simple; invest the same amount of money in regular intervals. This strategy can be used during any market trend, up or down. The key is to not change or falter from the amount and the time intervals. Don’t tamper with it at all, and be disciplined to follow this method long term. This will remove all emotion out of your investments and you don’t have to worry about timing the market.
To conclude, we are humans, it is almost impossible not to factor emotion into our day to day lives. However, using these simple methods of dollar-cost averaging and diversification, you will stop these bad investing habits and succeed in the long run. To further remove emotion, I suggest doing passive investments, so that you are not the one looking over your funds.