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Emotional Investing: How good or bad a financial decision is it?

The emotional brain sub-consciously dominates situations and can impact an individual while they make their investment decisions.

Emotional Investing: How good or bad a financial decision is it?
Factors like mood, cognitive bias, emotions, and sentiments impact the behaviour as well as the decision-making ability of the investor.

By Akhil Modi, Associate Director and Product Head, Digital Business Group, JM Financial

At our core, we are not always rational beings. Emotions regulate our behaviour and influence our decisions to a large extent. The emotional brain sub-consciously dominates situations and can impact an individual while they make their investment decisions.

Factors like mood, cognitive bias, emotions, and sentiments impact the behaviour as well as the decision-making ability of the investor. The intensity of the emotional involvement in investment decision-making depends on various factors like experience, peer experience, fear, and level of excitement amongst other things.

What is Emotional Investing?

Emotional investing is a strategy wherein investment decisions are made based on emotions rather than fundamentals. The investment decisions are impulsive and not well thought-through. These types of investment decisions are more reactive in nature as the investor makes decisions based on the volatility and swing in the market rather than research and fundamentals.

Why do investors make decisions based on emotions?

Our emotions sway as the market rises and falls. It is natural to get anxious when the markets fall and confident when the markets climb upwards. But our decision-making ability should not be governed by anxiety and confidence. Very few seasoned investors have control over such emotions and acting solely based on such emotions can have a detrimental impact on one’s overall portfolio.

The fear of missing out is another reason behind making emotional investing decisions. The investor tends to follow a herd mentality and invests under the fear of missing out on the gains in spite of knowing the investment is being overpriced. Another factor behind making such decisions based on emotions is the fear of loss as the magnitude of loss on an investor is anytime more than the impact of gain from an investment.

How to avoid Emotional Investing?

The stock market can either generate wealth for an investor or eat up all of their investment. Understanding the different phases of the market will give investors a better chance to make sound investment decisions. Broadly speaking, the market goes through four phases – Accumulation, Growth, Distribution, and Decline whereas the investors go through phases like reluctance, optimism, denial, panic, etc.

The various phases of markets can be a roller-coaster ride of emotions for an investor. The key is to ensure that as an investor, one is well-read and aware of market movements to not be affected by them on a daily basis. Continuously checking the market movement and the investments when there is market volatility tends to make the investor anxious and prone to emotional investing. It is always advisable to consult a financial advisor when in doubt about investments and to understand the right strategy. The Financial Advisor has an in-depth understanding of the markets backed by the experience to help investors sail through choppy waters and make decisions keeping short and long-term goals in mind.

The time spent in the market is more crucial than timing the market. Even the most seasoned investor is impacted by the movement in the market. Volatility is the nature of the market and the key here is to have a stable mind and back your decision with facts and fundamentals rather than emotions.

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First published on: 11-10-2022 at 23:36 IST