We are all irrational
Humans are irrational. We say we want one thing and then we do another. We want to be healthy and yet eat, drink and slouch to excess. We commit to saving money yet often succumb to spending.
Why do we do this? It’s simple: short-term gratification, instinct and emotion can get in the way of logic.
It’s essential you understand your emotions, so you don’t make short-term decisions that could end up sabotaging your financial future.
You’re going to feel these emotions at some point
Fear – when markets go down
When you’re scared, your thinking shifts to immediate survival. The prefrontal cortex – the part of your brain responsible for logical thinking – runs away and hides.
Greed – when markets go up
Our confidence surges as our returns race ahead. We think we know best and focus on the information that reinforces our existing beliefs.
…and one thing you can be sure of – the media is going to amplify whatever it is you’re feeling with headlines of booms, busts, war, Brexit and most likely of all, Trump!
Here’s what to do to stay cool
1. Acknowledge in advance that fear and greed are part of investing. Resolve to analyse these emotions when they arise.
Your instincts, your ‘gut’, your inner narrative should not be responsible for any money decisions. Use your head and be aware of the emotions and biases that can get in the way.
2. Don’t kid yourself that you can predict the ups and downs of the market. You can’t.
That thought in the back of your head, driven by fear, or greed, or the media, that makes you think that you can predict the future, is most probably wrong. While in theory, it is possible to time the market – to sell just before prices go down and buy back just before they rise – in practice, this is nearly impossible. Market movements are VERY difficult to predict so don’t waste your time trying.
3. Automate your investments by buying little and often
Regular investing each week or month, no matter what the state of the market, will teach you a non-emotional approach. You’ll buy low, high and everything in between. You’ll capture the average return of the market – about 7% historically*, which over time should lead to you doubling your money about once every decade. All you have to do is keep a lid on your emotions! To remind you, these levels of return are not guaranteed as past performance is not a guarantee of future performance and as with all investing you could get back less than you originally invested.
*Barclays Equity Gilt study