Stories of rising inflation, increased living costs, and volatile markets dominate the news headlines in 2023. In times of uncertainty like this, the value of investments can often rise and fall more than normal.

Naturally, many people are concerned about how this may affect their financial plans.

A study reported by FTAdviser shows that 61% of those surveyed discussed market volatility with their financial adviser in the past year. Unfortunately, when people panic about a dip in the market, they may make rushed investment decisions to try to protect their wealth and avoid losses.

Financial advisers estimate that these emotion-led decisions could be costing investors up to 2% of their returns each year.

As such, most advisers urge against making reactionary decisions during periods of market volatility. In fact, it is often best to do nothing because markets may well correct themselves and you could regain any short-term losses in the future.

Conversely, if you change course and sell investments, you may miss out on potential growth when the markets bounce back.

So, if you can avoid short-term, reactionary decisions and adopt a long-term strategy instead, you may be more likely to see positive returns in the future.

Here are three financial habits to help you avoid emotion-driven investment choices.

1. Stop checking your investments so often

A study reported by CNBC found that 49% of people check their portfolio’s performance every day.

Investment apps make it easier than ever to constantly monitor your money, but this may not be a good idea as you might perceive the performance to be worse than it is. You’re more likely to focus on short-term dips, and this could mean that you let panic guide your decisions.

However, if you take a long-term approach and consider the wider performance over a span of decades rather than weeks and months, for example, it helps put things in perspective. 

A short-term dip is not as concerning when you can see that they are a regular feature of the stock market, and they tend to correct themselves over time.

The following graph shows the performance of the FTSE 100 between April 2003 and April 2023:

Source: London Stock Exchange

As you can see, there is a general upward trend, and the overall value of the index has grown significantly in that 20-year period.

However, during that time, we experienced the 2008 financial crisis and a global pandemic, both of which caused significant market downturns, clearly displayed by the troughs on the graph at those times.

If you were checking your investments daily during these events, the short-term volatility may have distressed you. But if you sold your investments at this time, you would have missed out on potential future gains when the market corrected itself.

You would have more than doubled your wealth if you simply held your investments for the full 20-year period, regardless of any fluctuations.

This is not specific to the 2008 financial crisis or the pandemic either. In fact, CNBC reports that the best stock market days often follow the biggest dips.

So, trust in your long-term investment strategy and avoid checking your investments too often, because it can encourage you to focus on short-term movements, leading to unnecessary worry.

2. Look out for cognitive biases

A cognitive bias is a pattern of thinking that deviates from rationality. In other words, your brain may be hardwired to over-simplify ideas, ignore evidence, or otherwise make illogical decisions.

There are several common examples that can lead to emotion-led investment decisions and potentially harm your returns.

• Loss aversion – Loss aversion is a well-documented cognitive bias that causes you to feel the pain of loss more acutely than the pleasure of gain. As such, you will work harder to avoid investment losses than you will to seek growth. So, when the market dips, you may panic and sell investments to avoid further losses. But in making this decision, you completely ignore the possibility that the markets could bounce back and provide significant gains in the future.

• Confirmation bias – Confirmation bias is the tendency to seek out information that supports an existing opinion or theory and ignore anything that disproves it. If you are concerned about the value of your investments dropping and you think that selling them may be the best option, you can easily give more weight to the potential benefits of this – avoiding further losses – while tuning out any information that suggests that the value could well increase again in the future. The same is true when balancing the risk of a certain investment as you may single out examples of positive returns and ignore any negative ones.

• The “house money” effect – Treating your investment strategy like a trip to the casino may not be a good idea, but many people unknowingly do just that. The “house money” effect refers to a phenomenon whereby people make riskier bets at the casino after a big win because they don’t see it as being their money, they view it as “house money”. You may fall victim to this mentality if you see particularly good investment returns, and make riskier decisions with your investments as a result. But it’s important to remember that your measured, long-term approach netted those returns in the first place, so changing your strategy now may not be sensible.

Anybody can be affected by these cognitive biases but the good news is, once you are aware of them, you can be better placed to avoid them. So, before making any changes to your investment strategy, you may want to consider whether you are making a logical decision or if it is driven by a certain cognitive bias.

3. Focus on your goals

A goals-based approach is crucial because it determines what you need from your investments.

In many cases, you do not rely on the funds in your investments in the short term, as you are trying to build wealth for the future. And in that case, it may not matter if the value temporarily drops, provided you still see growth in the long term.

If you are investing for retirement, for example, and you plan to continue working for another 20 years, short-term volatility will not disrupt your goals because you have enough time for your investments to potentially regain any losses.

Keeping your goals at the forefront of your mind helps you put things in perspective and reminds you what you’re working towards, so you may be less likely to make reckless decisions.

Working with a financial planner can help you establish what these goals are, so you can develop an investment strategy to achieve them. 

When you find that emotions are getting in the way of your investment decisions, simply return to those goals and continue following your strategy. That way, you can ride out periods of market volatility without upsetting your financial plan.

Get in touch

One of the benefits of working with Ardent is that we can reassure you during times of turmoil, so you don’t rush into any poor investment decisions.

Please contact us on hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top-Rated firm, you can be sure that we’re a bona fide company providing excellent advice and high-quality service.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.