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How to Avoid Emotional Investing

Kira Brecht

Valentine's Day is just around the corner and you may be planning some surprises for your loved ones, including professions of love with some chocolate and flowers thrown in. When it comes to investing, however, emotions are best left at the door. Fear, greed and other emotional signals from the amygdala part of your brain, can easily derail even the best-laid investing plans.

Emotional investing occurs when investors make drastic decisions about their money and assets based on a feeling of how the market is performing rather than how the market is likely to perform long term, says Zack Shepard, vice president of Matson Money in Scottsdale, Arizona.

Fear and greed are often the two major emotional drivers when it comes to investing errors.

[See: 13 Ways to Take the Emotions Out of Investing.]

Fear often happens during a market pullback, says Arian Vojdani, investment strategist at MV Financial in Bethesda, Maryland.

"Let's say the market is having a correction and is down around 8 percent -- panic sets in and you sell because you fear further draw down," Vojdani says. "We know corrections are short lived and the market will eventually turn back around. However, you panicked in this scenario and locked in your loss."

On the flip side, greed can wreak havoc with your portfolio as well. Let's say you see that your investments aren't keeping up with a benchmark or other investment that you have been hearing about.

Vojdani highlights this scenario: You're invested in company A, but company B has been gaining higher price appreciation this quarter. You sell company A to invest in company B in order to chase the higher gains. This is a decision based off greed, Vojdani says.

"More likely than not, you will be late to the game and will have missed out on the gains for company B and should have remained disciplined and allowed company A's price to appreciate, whether that company saw appreciation next quarter or next year," he says. "Discipline and not following the herd and your greed is key."

The November presidential election is a perfect example of the high emotions that can emerge during big market swings, which challenge investor discipline.

"We saw the Dow drop more than 800 points in after-hours trading with the unanticipated win for Trump. Had the election results occurred during the heat of a trading day, investors would have likely seen huge losses, but because all of this happened after hours, investors had time to cool off and get control of their emotions by the opening bell the next morning," says Chris Cook, founder and CEO of Beacon Capital Management in Dayton, Ohio.

The stock market recovered swiftly following the unexpected election result and rallied to new all-time highs into year-end. If investors had followed the emotional impulse to sell on election night, they would have missed out on the subsequent rally.

To achieve investing success you need to be invested for the long term.

[See: 9 Ways to Invest in a Post-Election Market.]

"This requires you to set aside your emotions when the market is in a correction or recession," says Michelle Scarver, principal at Exencial Wealth Advisors in San Antonio. "You have to fight your instincts and stay in the market."

The outperformance of the market always exceeds the downturns in the market, Scarver says. She points to a JP Morgan study that shows the average recession is 15 months, while the average market expansion is 47 months.

"If you can remain in the market during the downturns, you will reap the benefits during periods of expansion," Scarver says. "There are more of them, and they are longer."

"You should never rely on emotions when it comes to investing," Shepard says.

Here are seven strategies to avoid emotional investing.

Stay focused on long-term goals. "Investors need to see the bigger picture and remain long-term oriented. Typically, losses are more likely in the short term, so investors who make emotional, impulsive decisions could hinder the success of their portfolio," Shepard says.

Buy low, sell high. This requires you to set aside your emotions because you're doing the opposite of what the market is doing, Scarver says. "When the market is at a high, people tend to want to enter the market. However, this is the time to sell what has outperformed in your portfolio and buy what has underperformed. To help you buy low and sell high, pick a time once a year to rebalance your portfolio back to your target asset allocation. This forces you to sell what has become overweight in your portfolio and exceeded its target, and redistribute assets that have become underweight in your portfolio that are below target."

Maximize diversification. Instead of chasing home runs that can lead to underexposure or overexposure in any one sector, focus on seeking consistent returns by investing equally across 11 market sectors to protect against extreme market risks, Cook says.

Examine your motives for making a shift. If you're about to make a change in your portfolio, identify why exactly you're choosing to make that change, Vojdani says. "If the buy or sell decision you are about to undertake is because of a short-term market movement, that decision is probably based off emotion and shouldn't be executed," he says. "If your decisions are based on a long-term views and backed with data, that is more often than not a prudent decision."

Take the news with a grain of salt. Dramatic market news can be a factor injecting higher emotions around your investments. "Tuning out the headlines and everyday noise can be a great factor in limiting how often emotions will impact your portfolio," Vojdani says. "Reading insights from trusted sources or consulting with a financial advisor can prove immensely helpful. Also, data such as quarterly earnings and transcripts of quarterly earnings calls that companies share are great sources in making informed decisions."

Create a rules-based approach to investing. "By taking a mechanical approach of setting rules and sticking to them, you can eliminate emotion from the equation," Cook says. "Maintain discipline to limit reactions to the market to when predetermined rules dictate."

[Read: 5 Reasons Donald Trump's Presidency Will Include a Recession.]

Enlist a trusted advisor. Do your homework and work with a coach or advisor that has your best interest in mind, Shepard says. "Emotional trading can cost investors tremendously over a decade, so enlisting the help from a trusted professional will allow an investor to stay on the right track and avoid emotional hiccups," he says.



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