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How to control one’s emotions and avoid making hasty decisions

4 min. reading
Financial Education / 22 June, 2020

Raúl Rendon Portfolio Manager

Periods of panic and/or euphoria bring to mind the recurring question of how to control one’s emotions and avoid making hasty decisions. There are no general recipes for this because everyone has their own personality shaped through their experience, knowledge, etc. For example, a person who likes extreme sports will have a different concept of risk than, say, someone who likes more traditional sports.

The first step: Know yourself

You have to be very clear when defining your risk profile. In my experience, when an investor experiences significant periods of stress, it’s usually because they own investment assets that don’t match their tolerance for volatility and risk aversion.

This step is the most important one of all – no doubt you can think of more than one person who becomes conservatively aggressive in bull markets and starts chasing after fashionable assets only to switch to being aggressively conservative in bear markets, claiming that those assets didn’t fit their profile.

Consistency with your tolerance capacities and investments is the basis for moderating those periods of stress that can sometimes lead to the wrong decisions.

I’d like to share the idea of not judging decisions by the result (outcome bias) but by the decision process that leads to a specific course of action, a process that is very important when uncertainty and external elements form part of the formula. In other words, don’t automatically classify a bad result as a bad decision (and vice versa).

Once you’re clear about all this, you’re basically home and dry because the rest is mainly about discipline and order.

Next steps

Let’s be honest: the financial world is not without risk and no one can predict the future. So it’s normal for there to be times when your vision of an asset or assets differs from your initial expectation, leading to periods of stress.

In evolutionary terms, stress has served as a mechanism of the brain to try and protect us by preparing us to cope with potential threats. In these situations, our adrenal glands release hormones (such as adrenaline and cortisol) that affect our brain, accentuating certain biases (greater pessimism, less patience, rigidity mental, etc.) that are negative for investors because they predispose them to act impulsively.

There are two areas of action: one concerns your portfolio and the other concerns your personal health.

Regarding your portfolio

  • Be hyper-realistic. Accept where prices are currently and objectively assess whether the investment thesis has changed or has simply been deferred. Don’t be tempted into hanging on for a recovery if the arguments have changed. Remember that guilt or regret won’t get you your money back or help you focus.
  • Less is more (cognitive overload): News travels very fast these days, which means there’s a risk of becoming mentally saturated, and that can lead to a mental block when it comes to making decisions. Be selective with your sources of information and keep them to a minimum so that you can process the data you receive.
  • Corroborate your point of view (confirmation bias). It’s human nature to seek opinions that reinforce our own beliefs, so it’s wise to check different points of view. However, make sure the person you consult is sufficiently objective, and remember that ultra bears (who always expect a bear market) are just as bad as ultra bulls (who see opportunities for assets to surge at every turn). Markets have cycles and it’s important to adapt to all of them.
  • Don’t fall in love with your assets. Treat your financial assets as the means to achieve your medium to long-term goals and don’t keep an asset just because you have already spent time and/or resources on it (a sunk cost). You probably know someone who’s held on to an asset for a long time and won’t sell it because they hope they’ll recover their investment at some point.
  • Keep a log of decisions. Remember the reasons that led you to make a decision and what the outcome was so that you can extrapolate situations.
  • Diversification. There’s not much to say about this because the financial literature is very clear on this point.

Regarding your personal health

  • Exercise. This isn’t a trivial recommendation: regular exercise improves the quality of sleep and quality of life, which will help you handle periods of stress more skillfully.
  • Healthy eating. Avoid processed foods, alcohol, etc. Remember, everything you eat and drink feeds your brain.
  • Meditation and breathing techniques. These activities have various benefits. There’s plenty of literature on how meditation and breathing techniques strengthen the cerebral cortex (neocortex), the part of the brain that helps us make rational decisions.
  • Stress is part and parcel of the financial markets, and the greatest damage in investments occurs when memory and emotion work together, which is why I hope these tips will help you improve your mental health and, above all, improve how you manage your resources.

Good luck!

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