Investing entails having to make lots of decisions. You evaluate risks, calculate the potential upside, and ultimately make investment decisions according to an overarching strategy–all with the hope you’ll earn a decent payoff.
This holds true whether you’re investing in real estate, stocks, bonds, or alternatives such as cryptocurrencies. One of the most vital principles for making good investing decisions is to remain unemotional and rational.
Why is that so important, and how can you embody unemotional rationality when you have to make risky investment choices?
Benefits of remaining unemotional
Emotional and impulsive investment decisions can hurt you in a variety of ways. Most often, your emotions may give you a distorted sense of reality, and influence your thinking toward biased interpretations of essential data.
For example, say you invest in a stock that’s been on an upward trajectory for the past several months. You have total confidence that the company will be around for decades to come, the leadership is wise and competent, and its model will remain profitable for the foreseeable future.
One day, the stock takes a 10% dip due to bad news about some facet of their supply chain. On the surface, this news may feel devastating, and it certainly doesn’t feel good to see your investment lose a significant chunk of its value.
In this scenario, a rational, unemotional person is more likely to view the news as a blip on the radar, and keep in mind that the company probably has decades of growth ahead of it. The current dip is probably a temporary phenomenon, such an investor will decide.
An irrational, emotional person will interpret the situation differently, and possibly imagine worst-case scenarios. The investor might abandon their general program because people around him are screaming that the sky is falling.
How to make rational, unemotional investing decisions
What steps can you take to make more rational, less emotional decisions in your investing activities?
- Create a strategy (and stick to it). First, design a solid investing strategy for yourself. Document your risk tolerance, your key objectives, and the types of assets you wish to acquire. Define the risks you’re willing to take, the ones you’re not apt to feel comfortable taking, and how you should respond to various external events. Then stick to the plan. Whenever you feel the temptation to make an impulsive decision, study your written plan and see whether the decision falls into alignment with your vision. If it doesn’t, don’t go there.
- Read the news, but not all the time. Any investor knows it’s worthwhile to stay up to date on economic developments. So you probably ought to take in the news frequently. But you also shouldn’t consume it all the time. Most modern news sources intentionally try to whip up anxiety and exaggerate matters to get more clicks; if you study these kinds of articles too often, it will distort how you see the world. Take the reports in stride.
- Prioritise long-term decisions. Most investors should prioritize long-term decisions. Don’t buy a stock because you believe it’s going to skyrocket tomorrow; buy it because you suspect it’s going to remain valuable – or become substantially more so – in 20 years. It’s tough to adopt this mentality, but once you do, you’re apt to see everything from a different perspective. You’ll be less tempted to make knee-jerk, reactive choices.
- Exercise patience. This one is easier said than done, but try to exercise patience. If you feel yourself getting emotional, take a few moments, even a day or two, before you make any big moves. This is especially important for major financial decisions, such as buying a new house.
- Make use of limit orders. In stock trading, limit orders are a type of purchasing or selling command. Limit orders will only be executed if the price of an asset reaches a certain threshold. For example, you might place a limit order to buy a stock if it reaches $30 per share; if it’s currently $35 per share, you won’t actually purchase any until it reaches the $30 mark. Using limit orders to trade in advance prevents you from making purely reactive decisions. Instead, you set your safety parameters in advance.
- Pretend you’re advising a friend. One of the easiest ways to trick yourself into thinking rationally is to pretend you’re giving investment advice to a friend. When you get caught in the moment, and swept by your emotions, it becomes harder to think rationally. But when you see a friend experiencing intense emotions, you tend to regard the situation more neutrally. Imagine a friend contemplating the decision that’s in front of you; what would you suggest to that person?
You don’t have to be a purely rational, unemotional person like a Vulcan from Star Trek to be a great investor. You certainly don’t have to adopt these practices in the rest of your life. But if you’re able to separate yourself from your emotions and prevent them from leading you into making biased interpretations, you’re more likely to end up with favorable investment outcomes.
David Tobin did his degree in psychology at the University of Hertfordshire. He is interested in mental health, wellness, and lifestyle.