How does psychology affect investing?

When it comes to money and investing, we are not always as rational as we may think. Whilst investors should always try to keep things in perspective and not overreact to what is in the news, headlines concerning things like the cost of living, inflation increases, or market volatility, can make this difficult.

Every human being is driven by emotions. These emotions can influence our behaviour, which in turn can influence our investment decisions, causing us to make irrational or ill-considered choices. It isn’t wise to let emotions drive our investment choices, but some investors just can’t help themselves. In fact, evidence shows that personality can affect investment decisions and ultimately your overall wealth¹.

Investment decisions

We now live in a world where we’re surrounded by news, social media and ‘experts’, and you should be mindful of how reliable information actually is and how it applies to you and your personal situation. Emotions such as excitement, fear and being scared also play a part somewhat in making 'impulsive' decisions.

The following five principles are key for anyone who invests their money and can help you to keep a cool head when your emotions may be stirred up.

1. Set investment goals

Successful investing begins by setting measurable and attainable investment goals and developing a plan for reaching those goals and then committing to it.

Whatever you are saving for, consider your time horizon at the outset, as this will impact the type of investments you may consider. Keep your plan on track by evaluating the progress on a regular, ongoing basis.

Committing to your investment goals will put you on the path to building further wealth. It stands to reason that investors who take the time to plan for the future are more likely to take the steps necessary to achieve their financial goals.

2. Invest as soon as possible

It’s easy to say that it is better to invest early, but why? The well-known proverb ‘time is money’ could not ring more true in today's society. An early investment gives your investment more time to grow in value, however, this will also depend on your attitude towards investment risk and how patient you can be.

The earlier you invest, the more time you have for your investment to recover if you incur a loss.

You will also reap the benefits of compounding, where you’ll you earn interest on both the money you’ve saved and the interest you earn. The longer your money can benefit from the power of compounding, the bigger your gains may be as time goes on, although there’s no guarantee of this.

3. Invest regular amounts

By investing regularly, you could benefit from highs and lows in the market – via a process known as ‘pound cost averaging’.

This can be an effective investment strategy, as rather than investing in one lump sum, you invest smaller amounts on a regular basis. Some months your money will buy more shares or units, and other months less, which overtime could be beneficial.

Dips in the market, particularly in the early years, could even work to your advantage provided you have committed to investing for a lengthy period.

4. Diversify your portfolio

Diversification is spreading investment risk, the goal being to increase your investment success. Your investment portfolio should be split across several types of investment, so your money is less likely to be affected by any single event or economic development.

Where possible, make investment decisions and portfolio allocations based on your personal circumstances and goals and also consider the stage of life you’re at.

5. Resist the urge to panic sell

Your ability to cope with short-term volatility in your investments is just as important as the choices you make at the outset of your investment journey.

If there is a downward movement in the markets, the fear of incurring major losses could make it extremely tempting to sell your investments. Yet, while this may temporarily alleviate your concerns, doing so could put a significant dent in your long-term gains.

Try not to overreact to falls, resist the urge to sell up immediately; instead, sit tight and ride it out.

If you invest for the long term, any short-term volatility shouldn’t affect your ability to reach your investment goals over time. Keep calm and carry on building up your investments. History has shown that over long enough time periods, no matter what challenges the global economy has faced, markets do recover from downturns.

If news headlines about stock market volatility make you feel nervous, focus on your own personal goals and the long-term potential of your portfolio. This is a far more sensible strategy than making rash decisions based on panic or fear.

Please note: This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment(s) and the income derived from it, can go down as well as up and you may not get back the full amount you invested.

Source:
¹ 3/11/23 | LGT Private Banking | Your personality can hugely impact your investments

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