Investing and trading psychology explores the intricate connection between human emotions and financial decision-making.
In today’s intricate financial environment, it’s vital to create a detailed personal financial plan before entering the investment arena, regardless of your experience level.
Recognising your financial status and setting clear objectives is fundamental.
Below, I highlight nine essential steps to help you navigate financial choices wisely.
1. Assess your financial situation
Begin by honestly evaluating your current financial situation.
This step is especially crucial for those who have never formulated a financial plan before. Take a close look at your income, expenses, debts and savings.
Understanding your financial health is the foundation on which you will build your investment strategy.
2. Define your goals and risk tolerance
Successful investing hinges on setting clear objectives and assessing your risk tolerance.
Remember that investments carry no guarantees of profit and there’s always a possibility of losing some or all of your capital. Therefore, it’s vital to align your investment goals with your risk tolerance.
Whether you aspire to wealth accumulation or income generation, a well thought out plan tailored to your risk profile is essential for long-term financial security.
3. Evaluate your risk comfort zone
All investments come with inherent risks. Whether you plan to invest in stocks, bonds or mutual funds, the potential for loss is paramount.
However, embracing some level of risk can lead to greater investment returns.
If your financial goals have a long-term horizon, consider allocating a portion of your portfolio to riskier assets, while keeping shorter-term goals in lower-risk assets.
Balancing risk and return is key to a sound investment strategy.
4. Avoid external influences
While discussing strategies with fellow traders can be beneficial, it’s vital to avoid being influenced by others’ opinions when making specific trades. Stay true to your own plan, even if respected traders have differing views.
Constantly changing your strategy based on external factors such as news or others’ opinions can lead to poor performance and increased stress.
Trust your well-researched plan and avoid discussions that may cause you to second-guess your decisions.
Maintaining discipline and sticking to your strategy will help you to stay on track and minimise emotional decision-making.
5. Avoid allowing fear or greed to steer choices
Investing in financial markets often resembles a roller-coaster ride without safety harnesses.
One moment, the exhilaration of soaring investments; the next, a stomach-churning descent as hard-earned money dissipates. The interplay of fear and greed fuels this volatile journey.
These intense emotions can provoke irrational investment decisions. Fear may lead to overly cautious choices or avoidance of investing altogether, while greed can result in excessive risk-taking and speculative investments.
To circumvent these emotional traps, adopt a balanced investing approach that harmonises with your objectives and risk tolerance.
6. Document your strategy
US author and statistician William Deming once said: “If you can’t describe what you are doing as a process, you don’t know what you are doing.”
This greatly applies to investment. To ensure clarity and discipline in your approach, it’s essential to document your investment strategy.
Writing down your plan not only helps you articulate it but also serves as a reference during turbulent times, preventing impulsive decisions.
Moreover, having a written strategy allows for periodic reviews and adjustments in response to changing circumstances or objectives.
7. Set realistic expectations
Maintaining emotional discipline in investing entails setting pragmatic expectations.
It’s crucial not to anticipate rapid wealth accumulation or a consistent market-beating performance. Instead, prioritise attaining reasonable returns over the extended horizon.
This approach guards against the allure of pursuing fleeting investment fads or assuming excessive risk.
chief investment officer, Century Financial
By embracing a patient and realistic outlook, investors can foster a sustainable and less emotionally charged investment strategy.
8. Set benchmarks
To measure the effectiveness of your investment strategy, establish benchmarks that align with your investment objectives.
There are two common types of benchmarks: relative and absolute.
A relative benchmark compares your portfolio’s performance to a broader market, an example of such a benchmark can be the S&P 500.
An absolute benchmark sets a specific goal for your investments, such as a target annual return of 7 per cent.
9. Diversify investments
One of the fundamental principles of prudent investing is diversification. By avoiding putting all your eggs in one basket, you mitigate the risk associated with the underperformance of a single market segment.
Spreading investments across different asset classes, sectors and geographical regions can significantly reduce the risk of amplified losses.
Diversification allows you to balance portfolio risks and potentially increases your chances of achieving your financial goals.
To sum up, making well-informed investment choices involves your financial status, defining precise goals, comprehending your risk threshold, sidestepping external pressures, recording your approach, establishing performance benchmarks and diversifying your investments.
By adhering to these guidelines, you can construct a sturdy groundwork for your financial future, work towards attaining your enduring aspirations and adeptly handle risk.
Vijay Valecha is chief investment officer at Century Financial
