Psychopaths make lousy neighbors. But their no-emotion psychology is something everyone’s investment portfolio could use.
Emotions get in the way of investing. It’s normal to feel emotional painwhen you lose money on stocks, or to feel exhilarated when you make money on a stock. But emotions tell us that “this time it’s different.” Emotions also make us hate losing more than we like winning – which can also lead to bad investment decisions.
Experienced investors have rules in place to help reduce the effect of emotions in the investment process. One of these is a trailing stop, which we explained here. A trailing stop is a pre-determined level below the current market price at which you decide to sell your shares. This price level is adjusted if the share price moves up. That way, you know exactly how much you stand to gain (or lose) – as long as you stay disciplined and sell at your trailing stop level.
Another emotion-free way to invest is called dollar cost averaging. It involves buying a set number or dollar value of shares at a set and scheduled time – such as on a specific day weekly, monthly or quarterly. This is commonly done with exchange-traded funds (ETF) or mutual funds.
Regular, pre-established purchases (which you may be able to automatically schedule with your broker or fund management company) help remove the emotion associated with timing share purchases. There’s no drama in trying to get the timing “just right” if you remove emotion from the decision about when to buy – something which is almost impossible to get “just right” anyway.
In addition to removing the emotion from the investment equation, dollar cost averaging makes financial sense. When markets are down, you end up buying more shares at a lower price. But when markets are high, you buy fewer shares because they are priced higher.
For example, let’s say you decide to automatically purchase S$250 of the Straits Times Index ETF (SGX:ES3) on the last trading day of each month. In the first month, the shares are trading at S$2.94 per share, so your S$250 would buy 85 shares. A month later, the price has dropped to S$2.85, so, you would buy 87 shares. Subsequently the price rises to S$3.00, so you would buy 83 shares that month.
Over time, your average purchase price would usually work out to be less than if you try to time the markets yourself. In this case, after three months you would end up with 255 shares with an average cost of S$2.93. Thus the term “dollar cost averaging”.
Psychopathy in your life isn’t a good thing. But in your approach to investing, it is. It will help remove emotions in your investment decisions so you can limit your losses and avoid trying to time the market.