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The psychology of investing

Intro

You likely already know that you should invest for the long term rather than looking for rapid returns. You may have heard that beating the market is practically impossible or that you shouldn’t sell in a panic situation. Then why do many investors act in the other way, potentially losing a lot of money in the process, since these are well-known investment principles?

Today, we’ll look at how our brain can sometimes lead us to act in illogical ways, such as selling stocks during a market slump, but which, when viewed from an emotional point of view, make total sense. We are still human, after all.

You can prevent these common errors by learning how to invest with discipline rather than speculating.

We aren't as smart as we assume 

Our brains contain 86 billion neurons on average. They properly fulfil our basic needs, such as food and shelter, and keep us safe as we go about our daily lives. However, financial issues might be extremely challenging. This allows emotional responses to drive behaviour that needs a cool head and an objective view of the situation.

Let’s suppose t that you have an investment whose value is increasing. As a result, you feel good knowing that you made the right choice and that you understood the risk.

When the stock market crashes, you panic sell because, due to a brain wiring condition called loss aversion, you experience greater pain from losing $1,000 than joy from gaining $1,500. It is in these moments that you may make emotional decisions instead of rational ones.

So, how can you safeguard yourself and your money against the emotional errors that so many individuals make while making decisions?

The six disciplines of an investor (not a speculator)

Discipline #1: Make a plan.
Think about your objectives before making your first investment. Keep in mind that an investor seeks a sufficient return which is defines the investment goal. If your goal is to become wealthy quickly, you’re speculating rather than investing sensibly.

Discipline #2: Invest in what you know. 
It’s usually not a good idea to choose a stock just because all your friends are recommending it, especially if you don’t fully comprehend the underlying business. That would be speculation once more. When you first start out, you might not have the time or knowledge to thoroughly analyse investments. However, there are steps you can take to lessen your risk, which we’ll discuss in our following session.

Discipline #3: Make long-term investments.
Short-term thinking is one of the common signs that a person is acting speculatively. Due to market volatility, trying to generate quick money through short-term investing, exposes you to greater risks. Making investments over a longer time horizon is one of the best ways to avoid realizing losses.

Discipline #4: Investing regularly
It’s essential to invest consistently. This can be accomplished, for example, by setting up a recurring contribution to a fund, just as you would with a savings account. 

Being a disciplined investor means sticking to your plan and continuing to consistently increase your wealth. 

Discipline #5: Do not react to market news
The wisest course of action is to refrain from responding to market news if you have a plan and are investing for the long run. The exact definition of emotional investing would be this. You are more likely to engage in purchasing high and selling low when you respond to both positive and negative sentiment, such as rising stock prices.

Discipline #6: Pick the right times to review your portfolio. 
Avoid the need to review your portfolio every day or every week. Aim to check it once every three months and, if required, make changes in accordance with your goal. 

Additionally, this strategy eliminates the stress and pressure of monitoring individual investments, which could cause you to respond emotionally to the market. 

Key takeaway

Speculating is dangerous. Investors who are disciplined look at the long term, maintain composure, and follow the strategy.

In our next delivery tomorrow

We'll give you 5 more pointers and assist you in getting ready to make your first investment in our final email