When it comes to investing for retirement, it’s best to avoid your emotions. Learn how to avoid emotional investing.
It’s easy to tell someone to keep their emotions out of investing. From a practical standpoint, however, it’s a trap most of us fall into at one point or another.
“People say don’t have emotion in your trading, but it’s impossible,” said JJ Kinahan, chief market strategist, TD Ameritrade. “It’s money, and people are always emotional about money.”
Ever hear of a “mental stop?” That’s what some traders call a price level they might have in mind, but not necessarily on a computer screen. For instance, if you were to buy a stock for $30 a share, you might tell yourself you’ll sell if it falls to $25. It’s a mental promise, and only self-discipline can ensure that the sale occurs.
Often, however, emotion intervenes. You might decide that the rest of the market is wrong when the price falls to $25. You might even start adjusting that mental stop, promising you’ll hold on until $20, or $10. This is an example of emotions getting the better of you.
“Discipline—that’s the hardest thing to do,” Kinahan said. “If it weren’t, the diet industry wouldn’t be a multi-billion-dollar industry.”
Everyone has emotions, and few traders or long-term investors can get through their entire investing lives without sometimes falling victim to emotional trading. But in the long run, it might help to ignore emotion as much as possible and develop a thoughtful, objective relationship with the market and your holdings, especially on money earmarked for long-term objectives like retirement.
Here are some tips from experts on how to channel your inner robot and avoid falling prey to your emotions.
Some experts say that, to gain self-confidence, you need to know yourself—your strengths and weaknesses, as well as your choices and preferences.
“Investors have to know their limitations and acknowledge if they’re disciplined or emotional,” said Sam Stovall, chief investment strategist at CFRA.
To test that, check and see how you react when the market goes up 1% versus when it goes down 1%. If you’re tempted to sell on downturns, emotion may be in control. Long-term investors, however, need to handle the ups and downs of the market over months and years, so knowing you’re tempted to sell a long-term investment at the first sign of trouble is a good lesson.
“If there are two emotions that drive investors—fear and greed—I think fear is the greater motivator,” Stovall said. “Fear of losing money on the way down and fear of missing out on the way back to recovery.” Long-term investors prone to fear may want to consider professional investment assistance to make sure they don’t let that fear hinder their strategy.
You can apply emotion to relationships, food, or exercise. But with a long-term investment in stocks or mutual funds, it may work against you. “Be robotic,” Kinahan said. In other words, set targets and stick to them.
“You need a target to the upside and downside so you take emotion out as much as possible,” Kinahan said. “Set your targets before you get into a trade.” That could make it easier to get out if the trade starts going the wrong way, and also to take profits methodically if things go well.
Maybe you have a mental stop on an investment, but you can still give yourself a bit more discipline by taking advantage of the data that flash across your phone or any other easily accessed screen. The TD Ameritrade Mobile app can deliver basic price alerts on both iOS (iPhone + iPad) and Android Phone.
The mobile app can help you create an alert and get notified on your device when your price condition triggers. This feature can help manage your profit and loss targets on your positions, or it can keep you alerted on symbols or indices that you are watching and waiting to hit certain price thresholds.
“One of the good things is that technology can help, so that if you have a mental stop, you can start to at least engage when it’s close,” Kinahan said. “That is, if you have a mental stop at $25, you should start checking when the stock is at $25.25. That way, if you are inclined to procrastinate on your mental stop, at least you are engaging.”
Try setting up a warning signal to alert you when your investment is 25 cents to 50 cents above your mental stop. And if that’s not enough, consider taking the next step—a stop order.
“If you don’t have the ability to actually follow through on a mental stop, replace it with a digital stop,” Stovall said.
But remember: use of a stop order will not guarantee execution at or near the activation price. Once activated, this type of order competes with other incoming market orders.
“Investors tend to identify with their holdings,” Stovall said. “Maybe it’s a subconscious decision. People tell themselves, ‘I bought it so it must be good, so maybe I’ll throw more money at it if it goes down.’”
When people love a stock for emotional reasons, they’re liable to ignore warning signs about its weakness. “People say, ‘It’s going to be different this time. I know it’s going to come back,’” Kinahan said. “But the only thing different is that you might lose more money.”
And don’t start resenting your losing investments. They’re stocks and bonds, not people. “Just because you lost money in a stock doesn’t mean that stock owes you money,” Kinahan added. “Trade what you see, not what you want to see.”
If you're really unsure about your ability to keep emotions in check, and you think a close friend or family member may be more objective, you could consider letting them take a look at your portfolio. A knowledgeable third party may be able to provide some insight, if you're comfortable sharing your information.
You could also consider consulting a financial professional to get a more nuanced view of your investment strategy. A financial professional can allow you to still be part of the strategic planning even if your hand isn’t on the tiller.
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