The Danger of Your Emotions

Have you ever been to the supermarket with a list of grocery items, but somehow find yourself adding more items to your trolley? While you might have started off with a rational decision, in reality, most purchasing decisions are made based on emotions.

Similarly, studies in behavioral finance have shown that investment decisions are highly dependent on investors’ behaviors. Simply put, their trading decisions are often influenced by their emotions as opposed to logical or rational thinking. This is especially true during market volatile times such as during a bull or bear phase.

Citing a quote from Warren Buffett, What you need is the temperament to control the urges that get other people into trouble in investing”.

Thus, sometimes being a good investor simply means that you should be rational when it comes to making financial decisions, as opposed to emotional investing.

Below are 3 simple steps to help control your emotions during investing:

1) Develop a plan

The first step before you work on anything should be a well thought-out plan. For a start, you can start by setting guidelines or criteria on when you should buy, sell, or hold stocks. Once you have a plan in pace, remind yourself to stick to the plan.

Let’s use a hypothetical scenario. You are vested in the local transport conglomerate, ComfortDelgro (SGX: C52) and the stock plunges by 20%. At the same time, another hot stock like Starburst (SGX: 40D) in your portfolio surges up by 30% in a short time. What would you do?

If you have a firm plan in place, it becomes easier to hold off your emotions; “sell Comfort and make some money! Sell Starburst to cut your losses!”  Go back to your plan to decide your next move.

This also prevents one from chasing the “herd”. Just like what I tell my wife: when you see many people queuing up at one hawker stall doesn’t necessarily mean that the food is good, they may be just following what everyone else is doing.”

2) Exercise Patience

Patience is one of the keys to successful investing. Market crises come and go. There are some who gain from the crisis and others who burnt their fingers playing the market.

History has shown that markets have recovered after recessions like the dotcom bubble in 2000s and the long term trend is up. To put it into perspective, the Straits Times Index (SGX: ^STI) has returned an annualized 4.95% from year 1987 till now, without even inclusive of the dividends. One can also view periods of market uncertainty as wealth-building opportunities as good quality companies go on sale.

3) Focus on learning from your mistakes.

No one is spared from making mistakes, not even great successful investors. The key thing is to analyse what went wrong and learn how to avoid making the same mistake in future.

I would like to borrow a quote from Warren Buffett that says: “Can you really explain to a fish what it’s like to walk on land? One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value.”

A good habit here is to consistently recording reasons whenever you buy or sell a stock. This way, whenever you look back in the future, you can really measure your results and see if you are going in the right direction.

Foolish Bottom-line

To sum it up, you are in fact, your worst enemy. It is easy to be controlled by emotions such as greed and fear, and allow them to dictate your investing decisions. More often than not, it results in poor performance for your portfolios.  A disciplined approach to investing will help to improve your performance dramatically. For more tips on investing, click here now for your FREE subscription to Take Stock Singapore, The Motley Fool’s free investing newsletter. Take Stock Singapore shows how you can GROW your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.