Science says emotions and investments don't mixA 2005 study published by the Stanford Graduate School of Business demonstrated that fear can lead individuals to make poor choices. The study gave participants $20 and asked them to play in a 20-round gambling game. For each round, they could spend a dollar on a coin toss. If they won the toss, they would gain $2.50. If they lost, they forfeited the $1 they spent to play. Each round, participants were also given the option not to play. Although it financially made sense to play in every round, the Stanford researchers found participants became more cautious about playing as the game progressed, particularly when they lost the coin toss in previous rounds. Interestingly, researchers separated participants into two groups: One group consisted of individuals who had experienced damage in the part of the brain that regulates emotions. On average, participants with normal brain function bet on 58 percent of the rounds while those experiencing brain damage bid on 84 percent of the rounds. The second group came out on top in terms of money, walking away from the game with an average of $25.70. Those with normal brain function ended with an average of only $22.80.
How to avoid an emotional responseTo make smart, rather than emotional, decisions about your money, Bolanis says you need to write out an action plan that outlines when and how you will react to the inevitable ups and downs that come with investing.
"The No. 1 rule of investing is to you need to determine your own philosophy and not let the noise distract you," she says.So rather than making an impulse decision to sell stocks after the market has a bad day, you refer back to your action plan and goals. An objective review of your tolerance for loss, personal investment goals and past investment history should guide your decisions. "You don't want to act out of fear," says Bolanis. "You don't want to fall prey to performance envy either." However, Bolanis says not to be too hard on yourself if you do react impulsively and make the wrong choice. "You need to forgive yourself if you make a mistake," she says. "There will always be another opportunity."