What is Emotional Investing?

02 Feb 2024

When making investment decisions, your emotions can get in the way of your logic and data, leading you to make sub-optimal choices and lose a lot of money along the way.

That’s why it’s essential to understand how emotions can influence your investment choices and to take steps to avoid letting them guide your portfolio astray and your hard-earned cash down the drain.

What is emotional investing?

The idea behind emotional investing is when you make investment decisions based on your feelings and instincts rather than logic or reason.

When we see news of the stock market soaring or a particular company doing well, many investors get caught up in the excitement and buy when the price is high.

Conversely, when the market is crashing, or a company hits a bad patch, investors may sell in a panic, leading to even more losses.

That’s why it’s essential to be aware of the power of your emotions when it comes to investing and devise a plan to ensure they’re not running the show.

How emotions can derail your investments

Anyone seeing influencers share the bags of money they’ve earned in crypto over the last few years has probably experienced some serious FOMO.

Seeing twenty-somethings become overnight millionaires and giving investment advice from their luxury yachts or private jets is enough to make anyone doubt their own life choices.

Of course, cryptocurrency, like any relatively new investment, is a rollercoaster of record highs and very low lows. For every new crypto millionaire, plenty of people have lost every penny they put in.

By the time there’s enough buzz for your FOMO to be triggered into wanting to invest, it’s likely that the price has already peaked, and you’re too late to the game.

The same happens when there’s a sudden drop in the market, and many long-term investors decide to cash out, thinking that this way, they’ll at least get something back instead of losing everything. When this happens, they’re often selling when the market is at its lowest point and miss out on the market rebound that will likely happen soon after.

If we look at the stock market’s performance over decades, it’s clear that it always goes up in the long run, despite the inevitable crashes and corrections along the way.

This is because the overall economy is continuously growing, despite the hiccups and recessions along the way.

What can you do to avoid emotional decisions

The best way to avoid making emotional investment decisions is to decide on your investment strategy and have a plan.

Then it’s a question of sticking to your strategy without being swayed by short-term fluctuations in the market.

Here are some of the things you can do to make sure your emotions don’t get in the way of your investment success:

  • Define your goals.

Deciding what you’re trying to achieve with your investments is the single most vital step to ensure you won’t lose sight of the big picture.

What is your investment horizon; are you looking to save for retirement, or do you want to make some money to fund a major purchase? Are you investing money you won’t need for a long time, or can you not afford to take any short-term risks?

Answering these questions will help you set the right goals and determine your best investment strategy.

  • Build a diversified portfolio.

One of the best ways to reduce the risk of your investments is to spread your money across a range of different asset classes and markets. This way, if one investment falls in value, you’re not putting all your eggs in one basket.

  • Consider passive versus active investment.

Active investing involves trying to beat the market by picking individual stocks or other investments. Passive investing, on the other hand, simply consists in buying a broad range of assets that typically replicate the overall market and holding them for long-term investing.

Passive investing is often seen as a less risky option, as it’s more likely to provide you with solid returns over the long term.

  • Leave room for your values.

While it’s not advisable to decide when to buy or sell based on emotions, there’s still room for your investments to reflect your personal values. The idea of ESG investing speaks to the growing trend to prioritize environmental, social, and governance issues when making investment decisions.

Companies, investment funds, and even whole countries are increasingly being graded on their ESG performance. The information on how they perform regarding sustainability, diversity, human rights, and other social issues is becoming more readily available.

It’s important to remember that investments are a long game, so it’s never a good idea to make decisions based on a temporary whim. By having a clear investment strategy and sticking to it, you’re more likely to achieve your goals, maximize your return and avoid costly mistakes.