“The more emotional an event is, the less sensible people are.” — Dr Daniel Kahneman, 2002 Nobel Prize Winner for Economics
Although emotions are an essential part of what makes us human, some emotions may negatively impact our financial future. Emotions, both positive and negative, can at times overwhelm logic, making it difficult for us to make informed investment decisions. We call this emotional investing.
What is emotional investing?
An emotion is a feeling caused by situations that you are in or by the people you are with. If you have watched the movie Inside Out, you may recall the five animated characters each representing a different emotion: anger, disgust, fear, happiness and sadness.
Emotional investing is basically using any of these different emotions to make investment decisions.
There are four stages of emotions that we go through while making investment decisions:
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Emotional Investing Stage 1: The Optimism Stage
Emotions involved: Optimism, excitement and thrill Expression: “Yes! I am one step closer to getting my dream car.”
As markets rise, a positive feeling starts to take over. With a market rally, we quickly buy and feel elation when we see our portfolios increase in value. The subsequent growth in our portfolio makes us feel more confident and optimistic.
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Emotional Investing Stage 2: The Anxiety Stage
Emotions involved: Anxiety, denial and fear Expressions: “Is this the top, are we in a bubble, should I get out now?” “Okay, this is only a temporary downturn. Should I HOLD?”
As markets peak and signs of a declining market emerge, the sudden turn of the trend triggers different decisions among investors. Some are confident that it is just a temporary downtrend, while others are contemplating if they should exit the market.
Emotional Investing Stage 3: The Panic Stage
Emotions involved: Depression and panic Expression: “If they are out, should I exit too?” The downturn continues, causing panic. This is where losses start to build up. The reality of a bear market is clear and investors are exiting the market.
Emotional Investing Stage 4: The Stage of Hope and Dismay
Emotions involved: Mixed feelings Expressions: “But…I don’t have much money left to invest.” “Will there be another low? Maybe I will just wait out for a little longer.”
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At this stage, just as the market is making a comeback, investors may still be cautious and wary, wondering if the market will continue to climb. Some may still be reluctant to invest at this point, even if prices are relatively low and upside potential is evident.
Eventually, the prices rise, more people are willing to join in the bull run and we start to see a glimpse of hope! Right under our noses, we have been caught up in an emotional investment roller-coaster ride. But we are only human, so how can we separate our emotions from our investments?
Prepare for the expected with Dollar Cost Averaging
The investment strategy of Dollar Cost Averaging (DCA) means investing the same amount of money in a stock on a regular basis, regardless of the share price. It automatically adds a small amount of money to your portfolio according to the frequency of your selection, for example, weekly, monthly or quarterly. This will help you to eliminate the temptation to time the market, and remove the worries of investing at the wrong time.
For example, you plan to invest $1,200 in ETF A at the start of this year. To reach that amount for your investment, you have two choices: 1. Invest the full amount at the start, or 2. Invest $100 each month. While it might not seem like there would be much of a difference, if you choose the latter, you may end up with more shares in the end compared to if you had bought everything all at once. Let’s take a look at this illustration:
Assuming you purchased $1,200 worth of ETF A in Month 1, you would end up with a total of 200 units. With DCA via Share Builders Plan, the average unit price and cost of investment are lower, as illustrated in this calculation:
This means you have made almost 50% more just by using DCA! Cycles exist in all markets. Therefore, it is difficult to time the market as prices fluctuate all the time. Therefore, DCA makes use of market fluctuations to your benefit by managing market risks and ensuring that your investment costs are spread out. One way you can make use of DCA for your investment is via a Regular Savings Plan (RSP). At PhillipCapital, there are three types of RSPs: Share Builders Plan, unit trust RSP and recurring plan. Always remember that life is a marathon, not a sprint. The same goes for investing. Embrace your emotions, but avoid emotional investing.
Claire Tan Si Ning is business development assistant manager with Share Builders Plan Team, Phillip Securities
