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• Keep Emotions in Check When Making Investment Decisions

Keep Emotions in Check When Making Investment Decisions

written on March 04, 2011 by Frank Fantozzi

The recession and the continuing sluggish economy have pushed investors’ emotions to the extreme. Deciding what to do with your investments during tough times can be difficult, and emotions sometimes get in the way of making sound choices. But there are ways to maintain your objectivity.

Effects of emotion
One reason emotions can come into play is that people tend to extrapolate future performance from recent trends. When the markets are moving steadily downward, for example, fear can kick in. In an effort to minimize their losses, investors may unnecessarily lock them in by selling otherwise good stocks at bottom-of-the-market prices and then holding funds in cash while the market rebounds.

In difficult economic times, investors also may overlook potentially good buying opportunities, instead seeking “conservative” investments, such as money market investments. But because of their limited appreciation potential, these are a poor choice for many long-term investors who need to keep their assets growing faster than inflation.

On the other hand, people often don’t like to admit when they’re wrong. That stubbornness can cause investors to hold onto a bad stock (one with little potential to rebound) rather than cut their losses and reinvest the remaining proceeds into a better opportunity.

Too much information focused on short-term market conditions — made possible by the Internet and 24-hour financial news networks — can also lead to poor financial choices. When investors don’t know how to prioritize what they read or hear, they may become paralyzed with indecision or resort to unprofitable strategies, such as excessive trading.


Controlling emotions
Even though it’s natural to experience emotions in response to market volatility, there are steps you can take to reduce their impact on your investment decisions. For example, take advantage of automatic investment plans. Offered by most financial institutions, these plans allow you to invest set amounts of money at regular intervals. By investing on a schedule, you can avoid the temptation to buy and sell at inopportune times, and actually buy larger quantities when prices are lower.

It’s also important to develop an individualized wealth management plan. Your financial advisor can help you determine the appropriate asset allocation for your age, goals and tolerance for risk. Be sure to record these goals, making them as specific as possible. Stick to your plan, regardless of what’s happening in the market, and meet regularly with your advisor to discuss any needed changes to your plan.

Finally, diversify your portfolio. As the truism goes, avoid putting too many of your eggs in one basket — whether it’s your employer’s stock, a “can’t miss” opportunity your friend is touting, or just a successful investment held for many years. Owning various types of securities that will respond differently to changing market conditions is one of your best defenses against market volatility. Knowing your portfolio is well positioned can help reduce your temptation to make poor financial choices.

Make sound investment decisions
Investors have endured a years-long emotional rollercoaster ride, as financial markets have taken extreme climbs and drops. To better keep your emotions in check when making investment decisions, have your financial advisor review your portfolio to ensure it’s diversified and help you create an individualized wealth management plan, if you don’t already have one in place.

Securities offered through LPL Financial. Member FINRA/SIPC.