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Remove the Emotion from Your Investing

The older (and wiser1) I get the more I find myself becoming less emotional about my investments.

It’s been well proven in many studies that us humans are flawed when it comes to investing. Our psycological reaction to losing £1,000 is much great than the thrill of making the same amount. Of course there is some logic in this as capital preservation is a cornerstone of successful investing. That said there is still a psychological human weakness present that impedes many investors.

Several buy to let investors I know suffer huge psychological trauma whenever a large repair bill hits the door mat. I have a good friend that recently sold his investment property because it was “too much stress”. He sold an asset that was earning him probably nearly £10k a year net because of the stress of calling a plumber in for boiler repairs half a dozen times in a couple of months.

To top it off he’s just put the equity into 100% UK equity. I wonder what he’ll do when the next stock market crash happens?

Most investors can benefit form being more mechanical about their investments. If you can take the emotions out of your finances then you’re much more likely to make sensible decisions. Lets look at some of the ways you car do this…

Take Your Losses With a Smile

Learning to accept losses is a key part of investing. In any diversified portfolio there will always be times when one or more holdings declines in value by a significant amount in a short period of time. For example there’ll be plenty of readers out there that have recently suffered at the hands of Tesco.

The mistake many investors make is to panic, think the world is going to end and sell. Solidifying a paper loss into a real loss is often a strong instinct we all feel, almost a necessity. The desire to avoid an even bigger loss if the price continues to fall often out weights the promise of a subsequent rise in the price.

Everyone knows that the key to investing is buying low and selling high. It’s still amazing that most tend to do the exact opposite. In ‘The Intelligent Investor’, the doyen of value investing gives some pretty solid advice:

“Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”

Benjamin Graham

What Graham is really saying is don’t submit to your in built emotional weakness by panicking and doing the wrong thing.

If you bought the asset at a price you were comfortable with yesterday and today the market moves prices down 25% then you should be able to shrug, crack open a wry smile, learn something from the situation and maybe think about buying some more2.

For a great real life example in what I’m talking about here check out TEA’s tale of two bears.

Passify Your Instincts

Of course in the above example you might have been seriously burnt for the long term if your original valuation of the asset was wrong. Back in 1999 I bought some shares in a ‘hot’ stock called Durlacher who were an intenet company incubator3. At the time I had no idea what it was worth and bought merely on the promise of quick capital gains. History proves that real valuation was a lot less than what I paid, in fact nothing.

There’s no easier way to beat yourself up than buy picking what you think is a red hot stock believing it is about to soar in value only to watch it’s price fall like a stone and never recover. Even in a well diversified portfolio these bad dogs can hurt your investing confidence.

For the above reason over the last few years my equity portfolio has becoming more and more passive. I’m continually favouring low cost ETFs and index funds to direct equity investments. As well as improving my increases of financial success this is also reducing the psychological drain my investing activity. On this section of my portfolio all i have to worry about is which areas to allocate my money (US, UK, EM, Equity, Fixed Income, Other), choose the lowest cost provider (ahem…Vanguard) and away I go.

When Tesco drops it’s eggs, it barely registers on my consciousness even though a large portion of my funds will own it. I’m emotionally secure in the knowledge that my diversification is high and I’m not going to be trailing the market.

Manage Your Risk

If you want to avoid emotional ups and down in your investing career then you may want to take a closer look at the risk profile you’re running.

If your long Bordeaux, short  bitcoin, heavily leveraged (trading on margin) or trading optionality you can expect to suffer some big losses every now and then.

100% equity? 50/50 Equity Fixed/Income? Got some property in the mix? Ask yourself how are you going to feel when the next financial crisis strikes? Will a 50% capital loss make you feel sick to the core?

If the answer is yes then you may want to increase the diversification of your portfolio. Try investing in assets with low or negative correlations.

Bud

Does It Work?

Following the Swiss National Banks surprise decision a few days ago I saw first hand at work some huge emotions on display, particularly for traders running EUR/CHF, USD/CHF and GBP/CHF books. Now these guys get paid handsomely to trade very un-diversified portfolios using other peoples money. Nonetheless when all hell broke loose in the FX markets I saw how emotional and unstable these traders got. It took some logical thinking from some fellow risk managers to stop some very bad (and expensive) decisions  being made by some incredibly intelligent people. Stress can make people very irrational.

Being an ice cold investor is not only better for the wallet but it’s also good for the soul.

As I’ve discussed before on the blog I’m long buy to let property. My strategy is low risk and not reliant on capital appreciation so if property prices fell by 50% tomorrow I couldn’t care less. I’ve de-risked my strategy so that i’ve decoupled my reliance on prices.

Since I began making efforts to be less emotional about my investments I’ve found I am making much better decisions. I no longer chase quick profits, I reduced my risk profile and I sleep better at night.

 

Notes:
1even if I do say so myself
2all other things being equal
3what ever that means!

{ 7 comments… add one }
  • UK Value Investor January 19, 2015, 10:16 am

    Hi UTMT,

    Couldn’t have said it better myself. Ben Graham talked about an “alert detachment”, a bit like looking at Amoeba under a microscope. Investors should have an awareness of what’s going on but no emotional attachment to the ups and downs of any particular Amoeba (or company). The goal is to watch and learn, not watch and panic.

    • Under The Money Tree January 19, 2015, 11:30 am

      UK Value Investor,

      “Alert detachment” is a great way to describe it. Of course as with most inbuilt/instinctive human behaviours not succumbing to it is often easier said than done! That said the trickiest part is simply being aware of it. Like most things, once you recognise and are aware of the issue it’s much easier to resolve.

  • weenie January 21, 2015, 9:10 pm

    I think I’ve got this emotion thing sorted. It’s disheartening when the markets are down and all I see are red numbers (as has happened a few times last year) but I haven’t been prompted to do anything. In fact, I just carried on buying on a regular basis as normal. Rather robot-lik in fact, so yeah, no emotions!

    I still check my portfolio most days, a habit I should get out but it’s done no harm so far!

    • Under The Money Tree January 22, 2015, 9:01 am

      Weenie,

      It sounds like you’ve got your emotions in check. You just need to ween (excuse the pun 😉 ) yourself off the incessant checking of prices!

  • Cerridwen January 21, 2015, 10:38 pm

    Strangely enough my biggest emotional issue is around when to sell – if prices are falling it seems best just to wait till they go up again, (hopefully) but rising prices need attention. I’ve had a couple of funds that have made big gains recently and I’m struggling with the decision about rebalancing. My asset allocation strategy tells me I need to do it now as things have gone off course but then received wisdom says only rebalance once a year. What to do and when to do it? 🙂

    • Under The Money Tree January 22, 2015, 8:51 am

      Cerridwen,

      I don’t think there are any hgard and fast rules that can be applied with regard to deciding when to sell a stock. Ofcourse as an active investor you need to really look at why the price is falling. If the fundamentals of the company (or the funds industry/asset focus) have changed for the worse then yes maybe selling is the right thing. If the price is falling due to the market’s schizophrenia then maybe you’re better off riding out the waves. The key is to avoid getting caught up emotionally in the markets schizophrenia!

      Regarding asset allocation I tend to just address this via new purchases. I’m in a ‘rapid accumulation’ phase currently so I simply redirect new capital to under represented parts of my strategy until I have the right balance. I guess in your case it would depend just how far off course your allocation you’ve been blown. If you were short Ruble and oil and long the Swissy then I’d definitely rebalance asap!

  • Anastasiya Shyrina April 30, 2015, 10:02 am

    “Being an ice cold investor is not only better for the wallet but it’s also good for the soul.” – 100% agree. If you engage in investing, you automatically take on some sort of risk. If you panick every time your portfolio goes down in value and can’t control yourself, investing is probably not for you. Even the lowest-risk portfolio has the chance of devaluation. We should stop being hostages to our emotions and start being rational instead. Easily said than done, of course. But that’s the only to become truly successful in investing.

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