Keeping Emotions Out of Investments
The ability to make good investment decisions requires investors to have a clear mind, good discipline and a certain level of emotional distance from their investments.
For some unit trust investors, investing can be an emotional experience. In the face of uncertain and volatile market conditions, it can be challenging for investors to remain rational and calm. Typically, our emotions can swing from exuberance during bull markets to fear during bear markets.
One of the common mistakes that investors make when they are influenced by emotions is “buying high and selling low”, the opposite of the often-quoted adage of “buying low and selling high". This happens when a market uptrend boosts confidence and gives a false sense of security, which emboldens investors to buy more when prices are climbing to their highs.
Conversely, when the market declines, some investors panic and start selling their investments out of fear of losing their capital. These investors often stay out of the market and fail to benefit from any subsequent market rebound.
Hence, buying and selling under the influence of emotions can reduce investors’ potential returns. More often than not, investors would have fared better if they had held on to their investments over the long term. To ensure long-term portfolio success, there are five useful strategies to keep emotions at bay when investing:
1. Have an investment plan
Setting an investment plan that meets one’s financial goals, time horizon and risk tolerance is the first step of unit trust investing. Having a plan helps investors focus on the big picture regardless of short-term market fluctuations. For example, if an investor is saving for retirement in 20 years’ time, he / she will have sufficient time to make up for any short-term setbacks. Given the goal of achieving long-term financial stability, the investor will also be less tempted to time the market.
2. Diversify your investments
Unit trust investors can diversify their portfolios by investing in funds across different asset classes, markets and sectors. The key asset classes are equities, bonds and money market securities. For equity funds, investors may invest in domestic, regional or global markets, as well as in sector funds such as property, healthcare or technology funds.
By diversifying their holdings, the investors’ portfolio return will not be dependent on the performance of any single asset class, market or sector. This can help reduce the tendency to make hasty decisions when a specific asset class, market or sector experiences a temporary decline or slowdown. Furthermore, a well-diversified portfolio can help investors ride through various phases of the market cycle.
3. Invest in both good and bad times
One of the most effective strategies that can help investors ride through market cycles is the Ringgit Cost Averaging (RCA) approach, where a fixed Ringgit amount is put into unit trust investments at a regular, predetermined interval regardless of the markets’ highs and lows.
With RCA, investors purchase more units when prices are low and fewer units when prices are high. Over time, this strategy can lower the average cost of investments. The RCA approach also takes emotions out of investing as the consistent plan of regular contributions helps investors to avoid making hasty changes based on short-term market fluctuations.
Financial markets are generally far more resilient than we think. Over the last 20 years, global equities have experienced several downturns, including the 2008 Global Financial Crisis (GFC) and the European sovereign debt crisis in 2011.
Yet, looking at long-term market cycles, the equity markets have rebounded after each consolidation. In 2008’s GFC and 2011’s European debt crisis, the equity markets have not only recovered their losses, but went on to post larger gains thereafter. Investors who had anxiously cashed out of equities during the downturns missed out on the markets’ subsequent recovery.
4. Do not be distracted by short-term market fluctuations
As equity prices can be volatile, investors should not let short-term price swings distract them from their long-term objectives. Instead, investors should rebalance their portfolio of funds when their asset allocation has changed due to market movements and is not aligned with their individual investment profile.
5. Seek guidance from a unit trust consultant
Investors can create some emotional distance from their investments by seeking professional advice from unit trust consultants (UTCs), who are able to assess their financial situations objectively and develop long-term plans that suit their needs. More importantly, experienced UTCs can help investors to stay on track instead of being distracted by short-term market movements.
In practice, investing without emotions is easier said than done. Nevertheless, by employing the strategies above and maintaining a long-term investment horizon, unit trust investors will be less inclined to make emotional investment decisions during market swings. This will invariably put them on a firmer path towards achieving their long-term investment goals.
This article is prepared solely for educational and awareness purposes and should not be construed as an offer or a solicitation of an offer to purchase or subscribe to products offered by Public Mutual. No representation or warranty is made by Public Mutual, nor is there acceptance of any responsibility or liability as to the accuracy, completeness or correctness of the information contained herein.