3 reasons it’s important to detach your emotions when you invest

At the heart of good money management is a reasoned approach to decision-making and impartial analysis of available information. But making sound financial decisions isn’t always easy and, for investors, a volatile stock market can cause stress and anxiety.

Your human emotional biases are hardwired and likely to drive you towards making poor financial decisions.

In fact, you may be surprised to learn that your behaviour can have far more impact on your investment returns than how your investment portfolio is made up.

Investing is a long-term game

To avoid losses due to poor judgement and bad decisions, it’s important to learn how to ride out the storm.

The first step to achieving this is to remember that investing is a long-term game. Due to the longevity of your investments, you’re almost guaranteed to encounter market volatility at some stage.

Since 1950, the S&P 500, a US index that tracks the performance of 500 large companies, has undergone.

On average, a bear market occurs every 7.78 years.

“By my count, there have been 15 “bear markets” in equities since the end of World War II—an average of one every five years, or so. The average depth of these declines was something in the order of 30%.” 

One of the most important things you should learn to do is ignore the media chatter that has a strong tendency to hype up a crisis.

Take a reasoned approach to financial decision-making

Remember, a reasoned approach to decision-making and impartial analysis of available information sits at the heart of good money management. This is something we talk about with all our clients at the initial meeting.

“We always have this conversation with clients upfront. We explain the plan and how the markets work. We’re experts but even we are susceptible to emotional reactions when dealing with our own money. So, we understand that clients who aren’t necessarily as financially literate will struggle to avoid letting their emotions take over.”

It isn’t always easy to detach your emotions when you invest, so here are three convincing reasons why it’s important that you do.

1. If you panic and pull your money out of the market, you could miss out on big gains

If you pulled out of the market when it was in decline, you may come to regret your impulsive reaction to find safe ground.

It may help to bear in mind that some of the worst days in the market are often followed by the best shortly after.

You never know which way the market will move from one day to the next but invest for the long term and short-term fluctuations matter less.

Yes, it can be a rocky ride but that’s why the long-term view always wins out. Holding your nerve when markets are falling can pay off.

Unfortunately, you can’t enjoy the highs without experiencing a few uncomfortable lows.

The chart below illustrates that investing £100,000 and then missing the top 20 days in the market over the next 15 years reduced the end investment value by more than £250,000, from £443,014 to £188,941.

A £100,000 investment in developed markets equities from January 2005 to January 2020

Source: Bloomberg, MSCI Daily Total Return Gross World Index

2. You could end up trying (and failing) to find the right time to reinvest

If you pull your money out of the stock market to protect your losses, you could end up making even more losses by failing to reinvest.

Many people in this situation try to “time” the market. Even professional fund managers struggle to do this successfully.

Instead of trying to time the market, reframe your thinking to focus on giving yourself the most time invested in the market.

Another way to make sure you make the most of being invested, without investing all your funds in one big lump sum investment, is to drip-feed your money into the markets. One of the best ways to do this is through regular investing, which you can do over a period of months.

“People that benefit the most are the ones that are contributing monthly. There’s a misconception that investing a lump sum is better than placing regular investments in a downside market.” 

If markets fall, investing at regular intervals means your money will buy more stocks or shares when their prices are low. On the other hand, if you invest sizeable sums irregularly, and the market declines, you might end up buying your entire investment at a higher price than you might have achieved otherwise.

Even professional investors and money managers with large sums to invest will drip feed their funds into the market over time. As the preferred strategy of seasoned professionals, it can be a useful approach for novice investors.

3. Making the wrong decision could damage your entire financial situation

An emotional response to financial decisions could be debilitating to your entire financial situation, affecting your ability to afford your lifestyle, and potentially even having a lasting detrimental impact on your future plans.

At the start of the coronavirus pandemic, the markets fell dramatically, causing many people to panic sell. The situation was unprecedented and there was no knowing what would happen next, but, as shown above, history shows that markets typically recover.

A real example of investment losses

For one investor, the coronavirus crisis was their first experience of a market in freefall. They had been invested for around 18 months when the pandemic hit the markets.

Their immediate response was to sell.

They sold every investment they had and are now trying to time the market and buy back in. At the time of writing, they are yet to reinvest any of their money. By withdrawing their investments, they’ve missed out on growth and every day that passes they risk losing more.

In stark contrast, another client who invested in the market in March 2020 has seen the value of their portfolio increase by 63%.

Stay calm and focus on the end goal

At First Wealth, we’ll coach you in behavioural finance to help you understand how your attitudes, habits, and behavioural biases could affect you and your money. When you know your blind spots, you can learn to recognise harmful behaviours and avoid making potentially damaging decisions.

To learn more, download our free guide, An Introduction to Behavioural Finance, that shares smart steps you can take to avoid financial mistakes.

Get in touch

If you’d like help managing your emotions and finances, please get in touch. Email hello@firstwealth.co.uk or call 020 7467 2700.

 The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.