5 Steps to Curbing Emotional Investing

Emotional investing is driven purely by feelings of anxiety or anticipation rather than rational thought. We all can relate to emotions running high due to various personal, political, or economic reasons. A major global pandemic, economic uncertainty, fluctuating equities, and contentious political times can all contribute to stress, making investors susceptible to emotionally driven investment decisions.

However, it's important to recognize that emotional investing rarely benefits investment portfolios. For instance, selling equities during a market decline might seem like a safe move, but it can lead to missing out on potential gains when prices rise again.

While it's natural to feel emotions during stressful events, your emotions shouldn't dictate your investment behavior. This is where a well-thought-out plan that aligns with your goals, age, and lifestyle comes in. Working with a fee-only financial advisor to establish an investment policy statement can help give you direction and peace of mind. It provides a roadmap, a sense of direction, and most importantly, reassurance that you're making the right decisions even in turbulent times.

Feeling anxious? Here's a to-do list for avoiding emotional investing:

1. Allocate your portfolio assets properly

Both your investment and retirement portfolios should be invested using an asset allocation strategy. This strategy involves dividing your investment portfolio among different asset categories, such as stocks, bonds, and cash, to maximize your portfolio growth and protect against market volatility. However, investing for growth involves taking on risk, and every investor has a different comfort level. Striking this balance is an integral part of stock market investing.

Equities typically offer the highest average annual return of any asset class – roughly 10 percent a year, on average, over the last near-century. However, because equity prices can drop, investors can also lose money in the short term.

To counterbalance that risk, a certain percentage of your portfolio should be placed in bonds or cash instruments, which offer high stability of principal. Cash instruments include certificates of deposit (CDs), money market accounts, and Treasury bills. You don't want the percentage devoted to bonds/cash to rise too high, though, because interest rates can be low.

Every investor has a different comfort level with risk and differing needs for growth in their investments. Typically, younger investors have higher risk capacity since, in theory, they have many years to allow their nest eggs to grow. Conversely, an older investor is likely closer to retirement and may have a lower capacity for risk. These situations are not always gospel – for example, a younger person may have capital needs (such as purchasing a home), and taking on substantial risk with every dollar saved might not be appropriate. It's important to discuss your situation with a financial professional.

2. Diversify, diversify, diversify

Remember the old saying, "Don't put all your eggs in one basket?" It's tailor-made for stock market investing! You need to diversify the equities you purchase by sector and geography. Your asset allocation strategy should also diversify your bonds and cash instruments.

Tough economic times can exert pressure on specific sectors. During the pandemic, for example, airlines did not do well. Diversification among sectors can help ease any blow. 

If you are a small business owner, your investment and retirement portfolios should diversify beyond the sector in which your business operates. If your business has to downsize or even goes under due to economic conditions, your personal assets shouldn't be positioned to feel pressure from the same forces. Again, diversify based your specific situation.

3. Utilize dollar-cost averaging

While falling stock markets can seem to erase money, they actually have certain benefits. Declining markets make equities cheaper! A $100/share equity that falls to $65 may seem like a scary spectacle to those that hold it, but not to the eager investor snapping it up at the new, lower price! It's a buying opportunity.

You can protect yourself from stock market volatility by utilizing a strategy called dollar-cost averaging. This strategy involves investing a fixed amount of money in a particular investment at regular intervals, regardless of the investment's price. You set up a given dollar amount every month to purchase securities, no matter what the overall market lands. 

Dollar-cost averaging protects you from buying only at high prices because you purchase securities steadily at all levels. The steadiness of your deposits makes it highly likely you will purchase during periods when the market is falling. 

This strategy is frequently used in 401(k) plans when you save a little bit for retirement from each paycheck. If you don't have access to a 401(k) through your employer (or want to save beyond solely that program), contact your fee-only financial advisor for guidance on how to set up an ongoing savings strategy.

4. Review your portfolios periodically

All investment and retirement portfolios should be reviewed periodically by you and your fee-only financial advisor. At that review meeting, consider any changes in asset allocation, strategy, or goals.

At the end of the year, portfolios should be rebalanced to maintain the ideal asset allocation. A period of rising or falling stock market returns can overweight or underweight you; rebalancing rectifies that shift.

5. Manage your emotions

Easier said than done! However, it's always good to have specific methods of managing emotional investing:

• Wait to make decisions: Always sleep on any decision before executing it.

• Remember history. From the Great Depression of the 1930s to the Great Recession of 2008, investors have weathered financial storms, including periods of high unemployment and significant market declines. Each time, we have recovered!

• Discuss your worries with a fee-only, CERTIFIED FINANCIAL PLANNER™ Professional. We can offer insight and ideas to soothe your mind and maximize your financial plan. We also develop a comprehensive financial plan that meets your life goals.

We Can Help

At Prism Planning Partners, we are fee-only CERTIFIED FINANCIAL PLANNER™ professionals committed to facilitating your important questions so that we can help you explore your many opportunities. We offer a broad array of financial planning and consulting services for our clients, including estate planning.