Taking emotion out of your finances

Investing is an emotional subject for most people. When things are going well we become confident or even euphoric about our investments. When things start going south, as most investments do at some point, we tend to get nervous — maybe a little desperate. In time, if things go really south, we start to feel defeated. The emotional rollercoaster can be mentally draining and, unchecked, can actually cause an investor to make ill-advised or even irrational decisions.

So how do you get off that emotional roller coaster and start making better investment decisions?

First, forgive yourself a little bit. All humans have a natural bias against taking risk. This aversion becomes particularly obvious when it comes to finances. In fact, even if the odds are in their favor, most people will not take the chance to make money if there is a possibility of loss. We’re that inherently cautious.

Second, get over it. Learn to view risk as something needed and not something to be feared. The simple truth is if there is no risk in an investment there is no opportunity for risk premium paid (a higher rate of return).

Third — and this is what I think is most important — learn to take a non-emotional, disciplined approach to your investments. This means developing a solid investment plan that establishes specific metrics for both buying and selling and, here’s the hard part, stick to it. Don’t allow your emotions, hunches or the advice of well-intentioned neighbors, in-laws, etc. cause you to deviate from your plan.

Similarly, avoid getting emotionally attached to an investment. If it doesn’t meet your established criteria, admit it, get out and move on. There are other things in life worth getting attached to but a bad investment simply isn’t one of them.

Granted, practicing a strict sell discipline may not seem as sexy or thrilling as following your gut, but doing so will allow you to avoid large loss on the downside and lock in profit on the upside. It’s an approach that will ultimately lead to far happier emotions about your investments.