Don't Let Your Instincts Rule Your Investments

Carefully crafted financial plans can be easily derailed by emotions. When faced with market fluctuations or personal situations, our primal instincts take over, urging impulsive actions that can hurt our finances.

The Lizard Brain vs. Long-Term Strategies

This impulsive urge stems from the “lizard brain,” an ancient part responsible for basic survival instincts like fight-or-flight. While invaluable for avoiding immediate dangers, it’s ill-equipped for nuanced tasks like investing.

Investing requires a different mindset. It involves planning, patience, and staying the course through volatility. Conversely, the lizard brain prioritizes immediate reactions to perceived threats.

Financial losses, while not life-or-death situations, can trigger the body’s stress response as if it were. This physiological reaction makes it harder to control emotions and can lead to poor investment decisions.

Disadvantages of Emotional Investing

While emotions can be a powerful motivator in life, they can lead to disastrous decisions when it comes to investing. Here are some key disadvantages of letting your emotions dictate your investment choices:

1. Selling at a loss during market downturns:

Image: Imagine a rollercoaster. The market can be compared to a rollercoaster ride, with ups and downs.
Data: Historically, the stock market has always trended upwards, despite short-term fluctuations. A study by Fidelity Investments found that the average equity investor under-performs the market by 2.44% annually, mainly due to emotional decisions like selling during downturns.
Explanation: When the market dips, fear can take over, leading investors to sell their holdings at a loss to avoid further potential losses. However, this often locks in those losses and misses out on potential rebounds.

2. Buying into overvalued assets due to excitement:

Image: Imagine a stock chart with a sharp, almost vertical, upward spike.
Data: A study by Dalbar Associates found that the average investor under-performed their chosen asset allocation by 2.32% annually over a 20-year period.
Explanation: Conversely, excitement and optimism can lead investors to chase “hot” stocks or trends, often when they are already overvalued. This can result in buying at the peak, just before a potential correction.

3. Making impulsive decisions based on news or hype:

Image: Imagine someone glued to a screen, frantically reading financial news updates.
Data: According to a survey by Charles Schwab 76% of investors admitted to making investment decisions based on emotions at least some of the time.
Explanation: Reacting to news headlines or social media hype can lead to impulsive decisions without proper research or consideration of your long-term investment goals and risk tolerance.

4. Difficulty sticking to a long-term investment plan:

Image: Imagine a crumpled and discarded investment plan document.
Data: A study by Vanguard found that investors who held their investments for longer periods generally achieved better returns compared to those who frequently bought and sold.
Explanation: Emotional swings can make it challenging to stick to a long-term investment plan, which is crucial for achieving your financial goals. Frequent changes based on emotions can disrupt your strategy and potentially lead to missed opportunities.

5. Increased stress and anxiety:

Image: Imagine someone holding their head in their hands, looking stressed and worried.
Data: A study by the American Psychological Association found that financial stress is a significant concern for many Americans, impacting their mental and physical health.
Explanation: Constantly worrying about the market and making emotional investment decisions can lead to increased stress and anxiety, negatively impacting your overall well-being.

By understanding the disadvantages of emotional investing, you can develop strategies to make more rational and informed financial decisions over the long term.

Regaining Control Through Cognitive Reframing

Fortunately, we can overcome the lizard brain’s influence. Research suggests “cognitive change,” adjusting our thoughts about a situation, can effectively regulate emotions.

Here are some strategies to use when faced with emotionally charged investment news:

Reframe the emotion: Recognize and acknowledge your emotions as normal. Instead of simply labeling them as “stressful,” reframe them as “a natural reaction to feeling off track.”
Reframe the problem: Look for the silver lining. Down markets, for instance, can be opportunities to invest at discounted prices.
Reframe your point of view: Take a step back and consider your situation objectively. Ask yourself how you would advise a friend in the same situation.

By taking the time to reframe situations, you allow your rational mind to catch up and guide your decisions, preventing impulses from driving your investment choices.

Jitender Chaudhary