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.

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!