What is emotional investing and 5 top tips to help you avoid it

It can be difficult to avoid making emotional decisions when investing, especially if the markets are volatile or you’re a novice investor.

However, this could be limiting your ability to reach your financial goals.

According to research published by Barclays, half of investors admit to making impulsive investment decisions, and two-thirds regret doing so¹.

Read on to learn more about what emotional investing is and find out how you could avoid it.

Emotional investing: Making decisions based on emotions rather than objective data

It’s natural to feel excited by a new investment opportunity or anxious about a downturn in the markets.

However, letting your emotions, rather than data and logic, drive your investment decisions could jeopardise your long-term financial plans.

So, it’s worth learning how to spot emotional investing. You could then take steps to keep it in check.

Signs of emotional investing

• Reacting to short-term market fluctuations – for example, impulsively selling investments during a market downturn or rushing to buy investments during an upturn in the market.
• Overlooking fundamental analysis – such as a company’s financial health and market position. Instead, emotional investors often rely on rumours and emotional biases when making decisions.
• Failing to manage risk – emotional investors may not give enough consideration to risk, and they often take on excessive risk.
• Focusing solely on one asset class or sector – due to personal preferences and emotional biases, instead of diversifying their portfolio.
• Trying to time the market – emotional investors often try to predict when to buy and sell investments, which is extremely difficult and may result in poor investment outcomes and missed opportunities for potential growth.
• Getting caught up in investment trends – focusing too much on what other people are doing and following the herd, instead of following your long-term investment plan.

Once you understand what emotional investing is and how to identify it, you can put steps in place to minimise it.

5 constructive tips to help you avoid emotion-based investing

1. Create a long-term investment plan

Adopting a long-term view of investing and creating a plan for achieving your goals could reduce the risk of being swayed by short-term market fluctuations and investment trends.

Additionally, investing for the long term could allow your portfolio to benefit from the powerful effect of compounding – making returns on your returns.

A financial planner can help you create a personalised investment plan that aligns with your broader life goals and considers your attitude to risk.

Furthermore, having a clear plan could give you confidence in your investment decisions. This might be particularly beneficial if you’ve previously been too risk-averse, which may have limited your returns.

2. Accepting the inevitability of market volatility

It’s important to remember that market volatility is inevitable – markets will move up and down in the short term.

Even if the market responds dramatically to changes in the global economy, such as war and deep recession, it’s unlikely that a downturn will last indefinitely.

So, accepting the inevitability of market volatility and remaining focused on your long-term plan could help you stay positive and avoid emotional responses – even if the value of your portfolio drops.

Additionally, a financial planner can build a bespoke investment portfolio tailored to your appetite for risk. This could provide invaluable peace of mind during periods of volatility, potentially making you feel less inclined to make emotion-based decisions.

3. Resist the temptation to follow the herd

From time to time, a new investment trend will appear that seems to promise rapid and generous returns.

It can be easy to get caught up in the excitement of such speculative investments, but there’s often a high risk of loss.

So, before rushing to invest, it’s worth considering where your information is coming from and whether you can rely on it.

A prime example of the risks involved in following the herd is the 2021 GameStop “short squeeze”. While some investors did make high and fast returns, those who jumped on the bandwagon too late were left out of pocket when the value of their stocks fell.

You could avoid these risks by focusing on your investment plan, instead of what others are doing. These could help you resist the temptation to act on emotions such as a fear of missing out.

4. Diversify your portfolio

Emotional investors may become overly focused on a particular sector or asset type that they’re familiar with or personally interested in.

This could result in increased risk if that stock or sector experiences a downturn.

Instead, by diversifying your portfolio – including different types of investment –  you could effectively balance risk and potentially improve investment performance over time.

If you’re unsure about how to diversify your portfolio or lack confidence in branching out into different types of investment, you might benefit from speaking to a financial planner.

5. Seek advice from a financial planner

No matter how much experience you have investing, avoiding emotion-based decisions can be challenging.

A financial planner can offer an objective perspective and act as a sounding board to help you keep your emotions in check.

Together, you can create a long-term plan tailored to your goals and appetite for risk, which could give you the guidance and confidence you need to make rational decisions – even in volatile markets.

Read more: Measuring the true value of financial advice

Get in touch

If you’d like to know more about how to create an investment plan that can help you avoid emotional investing, we’d love to hear from you.

Please email us at info@aspirafp.co.uk or call us on 01454 632 495.

Please note

The information contained in this article is based on the opinion of Aspira and does not constitute financial advice or a recommendation for any investment or retirement strategy.

The value of your investments (and any income from them) 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. 

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

¹ https://home.barclays/news/press-releases/2021/12/half-of-investors-admi...

285 - 03 2024