How To Avoid Being An Irrational Investor
As humans we have a natural tendency to act irrationally.
We’re sensitive to our emotions and feelings. We’re influenced by sights, sounds and smells. We often have good days when the weather is good, and bad days when the weather is bad – which really makes no sense at all, but it happens.
But that’s not such a good thing when you’re investing. When investing, you need to be as cool, as level-headed and as rational as possible.
What exactly are the dangers of being an irrational investor?
Some of the risks are that you might buy into investments or companies you personally like. Or avoid those you don’t like, maybe without any real good reason. You might be tempted to invest more when markets are on the up. Or jump ship when markets appear to be on the down. (Periods of volatility will have you running round in circles!) None of these approaches are rational, sensible investment strategies.
Yes, some investors claim to follow their instincts when investing. But that doesn’t really stand up to scrutiny as a serious technique. Neither does trying to time the market. See here for an interesting article on why you shouldn’t try to time the market.
So what’s the solution? How do you become a rational (and hopefully successful) investor?
The solution, as in other areas of life, is to have and follow a well structured plan.
These are the points we suggest you consider when creating your investment plan:
* Your objectives. Are you investing for income – or growth?
* Your time scale. Are you investing for a few years – or perhaps for retirement?
* How much are you able or wish to invest and when? For example, do you have a lump sum or do you wish to invest regularly each month, or both?
Tip. Committing to a monthly investment plan can be well worth considering. It can be a very good way of avoiding the risks of timing the market, and of falling victim to your emotions.
* Correct asset allocation, between different kinds of investments. Here’s a useful article which explains how this works.
* Under what circumstances might you want to reduce an investment, exit it altogether, or buy into new ones?
You can create an investment plan yourself of course. But it’s an advantage to have a financial adviser create your plan for you. As a third party they should be in a much better position to offer balanced, rational investment advice.
To create your investment plan your adviser should look at your individual financial circumstances, ask about your objectives, your timescale and your appetite towards risk. And they should also be able and willing to review it and recommend changes on a regular basis.
Of course, having an investment plan is not a 100% guarantee. But it’s much more likely to be successful than investing on an irrational basis depending on your own personal likes and dislikes, gut reaction or whatever the weather’s doing at the time!