Emotions are human, and investing decisions are never black and white. Being aware of your emotions when investing in the stock market can help you make better decisions so that you can sleep soundly at night.
Investors typically fall prey to two emotions – fear and greed.
Fear that the market will only go down, so they have to sell to cover their losses.
Or greed – that they missed their opportunity to buy low and are now getting a crappy deal on their stocks.
Personally, I know I often act from a place of fear.
I am more risk-averse than my husband and always fear that my picking stocks will only go down. This emotional awareness allows me to manage my emotions when making investment decisions.
How to manage emotions when investing?
Be aware of your emotional response
Knowing that your emotions are playing a part in your investing decisions is half the battle.
Emotional awareness can make you a better investor.
Are you more likely to act from a place of fear, from greed, or somewhere between?
Once you understand your own emotions, you can start to make more rational and logical decisions when investing.
Set up a plan
When you start investing, you start to understand your investing personality. We are all affected by our biases, and they can affect our decisions.
If you’re only invested in diversified ETFs or using Robo-advisors, you likely don’t need an elaborate plan. Make sure to contribute to your investments periodically, whether it is every week, every month, or every quarter.
But, if you tend to pick individual stocks or invest in more speculative (higher-risk) investments, like cryptocurrency, or small-cap stocks, you should consider having an exit plan.
Consider the following questions: What is a good price to buy? What is the price you would want to sell at? How much can you afford to lose?
Once you figure that out, you can automate and set up limits to reflect your plan.
Online brokerages offer mechanisms like stop-limits, stop-loss triggers to make sure your trades align with your goals. Having a plan can help you avoid emotional decisions and prevent you from acting out of greed or fear.
Turn off the market chatter
The news reports on the daily movements of stocks. That can be a lot of information to process every day. And you might lose sight of the bigger picture.
I advocate for anyone interested in the markets to listen to this chatter sometimes. You get invaluable insights and better understand the movements in the markets and your investments.
But the market chatter can be overwhelming! It’s hard to make sense of how these constant movements affect you.
For example, this week, the markets have had the worst week in months over the last five days – but over the last six months, the S&P 500 has risen 14% despite the “worst week.”
The negative sentiment in the news might have you believe that you need to sit out the markets. In reality, you cannot predict the bottom of a cycle. Nor can you move your investments in and out of the stock market in an efficient way to actually “buy the dip.”
Diversify
A popular strategy in investing is diversification. There is a lot of ways to diversify your investment portfolio. Diversification has proven to be a great way to escape the potential extreme downsides of investing. Another benefit is that it can provide an emotional buffer and prevent you from making impulse decisions related to your investments.
When you diversify, you reduce the risk that one investment can adversely affect your portfolio (aka concentration risk). A diversified portfolio can provide that emotional buffer you need to make rational decisions when investing.
One popular way to effectively diversify your investments is with the use of ETFs or exchange-traded funds. These popular, often low-cost investments are a great way to help you set up your assets and forget about them.
ETFs are diverse, and in many broad-based ETFs, you’re unlikely to see significant spikes and lows, smoother returns, which means that you are less likely to stress about your money.
Stay in it for the long haul
Over the long term, the overall markets have gone up. There is no evidence that day traders make money. Twice as many day traders lose money as they make money.
There is no proof that trading in and out of the market can help increase returns. As an individual investor, you may have to pay transaction fees, or you might not be getting the best pricing from your brokerage.
Even market professionals are often wrong about their calls on whether the stock market is at the bottom or the peak.
If you stay in sound investments for the long haul, then you take away the likelihood that you will act from a place of fear or greed.
Find comfort in Cash
Cash is King. It can bring you comfort when the market is in turmoil. Or it can allow you to buy the dip!
Focus on your cash balances, if you have enough saved up for emergencies, if you have enough to pay down your debts, or for your short-term goals.
Knowing that you have enough cash for short-term needs can help you keep calm even when the stock market is volatile.
Final Thoughts
No investment has a 100% guarantee of success. There are no fool-proof investments, and there is always a risk attached to your investments. There is always a chance that your investments lose money.
It is important to understand yourself as an investor. The more you know about yourself and your emotions around money, the more likely you will make knowledgeable decisions about your money. And that means you’re less likely to lose sleep over your investments.