Thinkinvestor. Emotions play role in investments

In this article, we discuss how emotions affect investment decisions and how to manage your emotions.

Reflexive Vs. reflective

Research into neuroscience has shown people who have lost their emotions because of brain damage cannot meaningfully evaluate risks associated with their decisions. This means individuals with a healthy brain can use emotions to make decisions. But emotions can also lead us to take hasty decisions. There is another issue. Our brain occupies about 2% of body weight but requires almost 20% of energy to function. That is a lot. Our brain, therefore, optimises its energy usage. For most decisions, our brain switches automatically to its reflexive process. Call it taking non-conscious actions if you will. A simple way to understand this is to remember the time you learnt to drive a manual gear-shift car. You, perhaps, paid more attention initially to how to shift gear than the traffic on the road! But once you were familiar with the process, shifting gears became a non-conscious action.

Using reflexive brain conserves energy for reflective brain (conscious decision) to process important decisions such as doing professional work and planning for retirement. If your professional work requires expending lot of brain power, your reflective brain is likely to be tired by the end of the week, if not by the end of the day. Taking investment decisions when reflective brain is tired is bad for your financial health. Why? To conserve energy, your reflexive brain will take over the decision process; you could pick investments that are emotionally satisfying, not necessarily ones that will help you achieve your goal. It is hard to control this switch from reflective to reflexive brain. So, what should you do?

Conclusion

You should reduce the number of decisions you make on investments. That way, you do not tempt your reflexive brain to make investment decisions. A simple way to do this will be to open a bank recurring deposit and set up a systematic investment plan (SIP) on an equity fund to finance each life goal. With your primary investment decision out of the way, you can deploy reflective brain to manage your short-term investments (trading portfolio). If you frequently trade in the market, recognising chart patterns could also become a non-conscious decision. Managing the trade and taking profit will still require using reflective brain.

(The author offers training programmes for individuals to manage their personal investments)