Getting sentimental over investments, fear of missing out on gains or losing all your money can lead to taking wrong decisions. A prudent way to deal with emotions and biases is to stagger your buy and sell decisions so as to ensure better outcome over a period of time.
Emotions are an essential part of what makes us human. But when it comes to investing, emotions can be tricky. Investment decisions are basically a quantitative exercise but often, investors unknowingly allow their emotions and biases to play a role while deciding upon their investment choices. Empirical evidence during the last two decades has shown that bad investment decisions are often associated with emotions. Let us discuss what are the common emotions and biases one should avoid while deciding their investment choices.
No sentimental value
An investor can develop illogical attachments to one’s holdings. For instance, you may hold some shares in your portfolio which have a sentimental value—such as shares inherited from ancestors, shares bought out of the first salary, etc. You may want to hold on to them even if it means losing a lot of money. All these emotions are irrational. So, ask yourself whether such holdings will make you rich? Or will they result in total capital loss? As an investor, one should not fall prey to such sentiments.
No fear of missing out
Often investors will chase shares that seem to be doing well, for fear of missing out on making money. This leads to speculation without looking at one’s own investment strategy. Such kind of fear leads to speculative decision-making. For instance, consider the latest cryptocurrency hysteria. Many investors chased crypto-based shares with unproven and unsustainable business models, fearing that their neighbours and friends were getting rich. So, over a period of time rational behaviour began to set in and crypto- based shares plummeted, and inexperienced investors were left with nothing.
No fear of losing everything
Another emotion that investors should avoid is the fear of losing everything. A more powerful emotion comes from the fear that they will probably lose all their investments. When market volatility causes large swings in the stock market, investors are frightened, causing them to side-line their investment to avoid a big sell-off or stock market crash. We have observed such behaviour in the wake of the recent financial crisis. Investors pulled out their money from the stock market as a reaction to the market sell-off. But they all missed out on the subsequently recouping of losses and the dramatic recovery.
Stagger buy and sell decisions
Another way to deal with emotions and biases is to stagger buy and sell decisions. For instance, you may want to buy 500 shares of ABC company. A prudent approach is to buy 200 shares at the current market price. The next buy order could be at 5 or 10% below the current market price and remaining shares could be bought at 20% lower than prevailing market price. In such a case, even if the share price moves up after the initial buy, you will still achieve gains on 200 shares and may move on to the next investment. In contrast, if the prices move down, you can buy more shares at a lower price. The same tactic could be used while selling the shares.
To conclude, patience and perseverance is critical, and investors should follow these simple steps to avoid emotional investing. This will produce better outcome for investors over a period of time.
The writer is a professor of finance & accounting, IIM Tiruchirappalli