Emotional management: The secret to being a good investor
“The investor’s chief problem—and even his worst enemy—is likely to be himself.” Benjamin Graham cannot be more accurate. While humans are built to be emotional creatures, unmanaged emotions can adversely affect your investment decisions and subsequent portfolio performance.
Climate of uncertainty
It is easy to tell yourself to be objective and remain calm so that you can avoid making emotional investment choices. However, how many of us can do this when prices swing?
The volatility in prices is all the more pronounced during this uncertain coronavirus period, which has forcefully catalysed digitalisation, triggered questions about the global supply chain, and paved a new way about global business operations. Spending patterns, manpower requirements, real estate needs and a multitude of other conditions will never be the same in a post-COVID world. This instability is further impacted by the potential changes in the political climate as the world tries to develop vaccines to combat the virus.
Here in Singapore, the country can enter phase three of its reopening by end 2020 should community cases remain low as the nation intensifies testing and contact tracing. This reopening provides opportunities and challenges to investors. While businesses can possibly operate closer to pre-COVID levels, businesses will likely need one to two years to recover to pre-coronavirus levels even as they seek new revenue sources, speed up digitalisation and innovate their products and services.
A roller coaster ride
COVID-19 is one of the most recent market swings, and most investors are susceptible to behavioural biases at every stage of the investment decision making making process. Psychological pitfalls are present throughout this cyclical process, from the moment investors start comprehending news, picking investment products, holding them, selling them, and selecting a new product to purchase.
When prices are dropping due to speculations of a second wave of virus infections, you may be tempted to double your position. However, should the price plunge even further, you may actually feel a sense of panic and decide to sell it off to avoid further losses. At this point, if the price recovers sharply, potentially spurred by vaccine cure speculations, you may feel that you have made a mistake on hindsight and be tempted to buy again. After all, it’s still cheaper than what it was in the past, so it appears to be an acceptable deal for now.
Do these thought processes sound familiar to you?
Investment Process - Roller Coaster of Emotions by Credit Suisse
This series of conflicting emotions, as outlined in Credit Suisse’s white paper on Behavioural finance: The psychology of investing, is not unique to any particular investor.
Staying objective
Chu Chui Laam, Senior Financial Consultant of LFA recalled, "When new clients approach LFA, we would sit down together and discuss both personal and investment goals at length. During these discussions, it is not uncommon for clients to be hesitant in selling off what we’ve identified as unsuitable investments or underperforming stocks. The client may believe strongly, often through speculations, that the stock would rise back from the ashes if they just ‘hold on a little bit longer’ or that he has ‘no choice but to keep going’ since he has sunk so deep.”
“However, the truth is that we all have a choice. At LFA, we believe in focusing on investment aspects that we can control, such as one’s goals and needs at various life stages. We are not keen on trading loss makers, or dabbling in random investment items based on speculations. Instead, we are dedicated in helping our clients structure a portfolio that suits their risk profile so that they are on track to achieving what matters most to them.”
To avoid falling prey to various cognitive and emotional biases, investors can avoid looking at headline news, and dig deeper. Focusing on what can be controlled instead is also helpful. For example, a sole investor is highly unlikely to accurately predict the start or end of a recession. However, one can manage his emotions and stay disciplined despite the market dips and swings by having monthly contributions to investment plans that fit one’s needs and risk tolerance. A structured portfolio, in this case, will go a long way in grounding returns.
In this regard, LFA financial advisors will be able to offer expertise and guidance to help you focus on actions that can value-add to your portfolio, leading to a less stressful and better investment experience.
Rewiring your brain
Warren Buffett said, “If you cannot control your emotions, you cannot control your money.” While many of us understand this concept, it can be difficult to control emotions. You are not at fault. After all, the human brain is not wired for disciplined investing and is subject to much mental errors.
Common mental errors
To combat these mental errors, it is important to be patient and look at the bigger picture when investing for the long term. More often than not, market situations tend to produce non-linear returns. There are months in which your investment may do well, and months in which the returns can be disheartening. As such, it pays to adopt a more flexible mindset and compare your returns with the market benchmarks instead of with what you imagine the future to be. The latter is inaccurate and filled with assumptions.