Letting emotions guide investment decisions can back-fire

• Fear, greed, optimism, pessimism, and other emotions can drive impulsive investment decisions.
• Panic selling, buying during a rally, and overcompensating for losses can negatively affect returns.
• Staying disciplined starts with knowing your personality and ensuring your investments are aligned to your goals.

Rashid and Salama have completely different personalities. One is very impulsive and emotional in decision-making. The other considers the pros and cons of everything until the time to decide is past. One seeks deals and the other will pay a higher price for the peace of mind that comes with a guarantee. It’s natural that their investment decisions are also affected by these traits.

The dread of facing losses, the apprehension that comes with uncertainty, the allure of making quick gains, decision paralysis, and fear of missing out are all part of the emotional side of investing. To be a successful investor, it is crucial to understand your emotional patterns, drivers, and mindset.

How can emotional investment decisions hurt?

• Panic selling during a downturn is one of the commonest examples of emotional decisions. In the rush to get out, investors end up locking in their losses, which would not have been realized had they simply stayed invested.
• Fear of missing out is the other extreme when it comes to investing. Buying something because everyone is buying it means you enter the market during a rally. Typically, prices correct in the long or medium term, leading to reduced gains, or even losses.
• Overcompensating refers to making impulsive and quick buying decisions to recoup recent losses.

How to develop discipline and minimize emotional decisions

The first rule is to know your investment personality, which defines your risk tolerance. Your appetite for risk – or how much can you afford to lose – depends, among other factors, on your emotional disposition.

Once your risk appetite is defined, create an investment plan, with a built-in response matrix that tells you how to respond to volatility or uncertainty on your terms.

When faced with panic or greed, go back to big picture questions that you had created when planning your investment journey. These are:

• Have my goals changed? Am I working toward other goals?
• Has the investment horizon changed?
• Has my financial situation changed?
• Am I comfortable with the risk buffer in my portfolio?
• Is there enough diversification in my portfolio?

The process of answering these can clarify where you stand and the way forward, even if it includes rebalancing your portfolio. Identifying your triggers and common responses to create a personalized plan is a great way to handle your investments.