A Science Magazine revealed that people tend to lose 13% of their IQ points during moments of financial stress, which causes them to make poor decisions. This could explain why many investors buy popular stocks at high prices during times of growth and sell low during times when the market falls, as opposed to waiting for conditions to shift. What if these investors could learn to control their tendency to panic? Perhaps, they would become better and well-balanced investors who are able to check their emotions and make more prudent decisions. How do we that? Here are some suggestions:
Avoid micro-monitoring returns. While the market can potentially bring enormous wealth to investors, going to the minutest level can trip a person’s nerves, according to Daniel Crosby, a behavioral finance expert and director at The Center for Outcomes of Brinker’s Capital. Looking at daily portfolio values can show a 42.5% loss within the day while an annual check may show only 23.8% within the period. Crosby claims that the latter practice will tend to provide greater confidence and enhanced decision-making.
Learn from history. The mean intra-year drawdown for the past 35 years, which is the price difference between highs and lows, has been 14%. Historical records show that in 27 out of 35 of those years, the year ended higher.
Remember how the market works. Stocks offer better results compared to other assets by 5%, based on a volatility-adjusted evaluation, according to Crosby. Investors who buy and hold their assets in the long-term have gained substantially from equity markets but those gains are accompanied by great risks during short periods of volatility.
Do not get attached with your stocks. John Foard III, president of Foard Wealth Management in Charlotte, North Carolina, warns investors from getting emotionally attached with their securities, since assets cannot reciprocate such affection, although they can prevent investors from selling them. He has seen so many individuals refusing to sell their stocks even if those stocks have ceased to be fundamentally sound, because they cannot accept the fact that they made a poor investment. There are some who say the stocks were passed on to them by their parents and do not wish to dishonor their parents’ legacy by selling. Foard points to such cases as clear proof of emotions taking over logic and sound fundamentals as bases for financial decisions.
For the venture capitalist, stay away from the herd mentality. The use of pattern recognition (herd mentality) often plagues decisions made by investors in venture capital, according to Minal Hasan, founder and senior partner of K2 Global, a venture capital company in California engaged in investing in fast-growing technology firms. Pattern recognition is another form of emotional attachment based on people’s fear of the new and the strange. This can lead investors from potential investments in novel and revolutionary technologies which do not fit the common pattern.
Apply a bit of intuition in investing. A healthy amount of intuition or gut feel can help an investor decide if a company does have mass appeal. According to Hasan, this helps determine whether a product will have a consumer base to help it soar in the market. Like in the case of Apple, elegance of design and convenience can carry a brand high above others. And that emotional connection can translate into huge sales for that particular brand.
Estimate how much you can afford to lose. During the planning stage prior to investing, compute how much loss you can handle in order to minimize your risks, according to Miguel Gomez, a registered financial planner of Lauterbach Financial Advisors in El Paso, Texas. When the market falls, many investors tend to feel down as well. Gomez says that admitting the possibility of losing on an investment will help in developing an individual to grow to become a prudent and successful investor in the future.
Ask questions. Before making an investment, ask yourself a battery of questions, says Gomez. This includes such questions as how the investment will benefit one’s goals, what is the worst case that can happen and how it will affect your life in the event the investments double or disappear.
Think and act deliberately. John B. Dinsmore, assistant professor at Raj Soin College of Business of Wright State University states that quick decisions and investments made without sufficient thought and evaluation are usually fraught with emotional stress and anxiety. He advises investors to take the time to decide, without being pressured or pushed into making the investment whatsoever, by listing the advantages and disadvantages of a certain investment.
Test your plan on those who know you best. Try to bounce off your friends who will not hesitate to tell you when you make emotionally-motivated decisions. This advice from April Masini, an etiquette and relationship guru, will help you in your decision-making process.
Consider opposites in emotions. If you are overcome by fear or anxiety when the market is down, it is time to feel happy and prepare to buy, advises Rick Salmeron, registered financial planner at Salmeron Financial Network in Dallas, Texas. Conversely, when you feel the urge to gobble up stocks when they become hot, step on the brakes and avoid the desire by aiming to attain greater levels of emotional control and stability.
Eat the right food to train your brain. Salmeron goes further by suggesting the use of food to help train the brain in making proper decisions. For instance, when he feels anxiety and fear from market shifts, he reaches for his “comfort food” (you can choose your own) to celebrate the opportunity to buy. On the other hand, when he feels giddy when markets prospects are bright, he eats “discomfort food” (licorice or any other unsavory food) to counteract the desire to splurge.
Stick to a strategy for asset allocation and rebalancing. Only through the process of rebalancing can you develop the discipline to buy low and to sell high, advises Kristy Peev, portfolio manager at Halpern Financial. Because it is counterintuitive, not many investors practice portfolio rebalancing.