Behavioral Finance: The art of letting go

Investing is rooted in emotion. The human brain, in its primitive state, recognizes two major emotions: greed and fear. Although mankind has progressed significantly from the age of “hunt or be hunted,” these emotions continue to teach invaluable lessons that shape human character, resilience, and maturity.

From childhood through adulthood, the burden of loss often outweighs the glory of gain. Whether it’s the loss of a loved one, a heartbreak, or severe losses in your portfolio, these experiences can leave us feeling gut-punched, as if all hope is lost. This feeling is your natural defense mechanism, signaling you to act—whether by fighting or fleeing.

In investing, emotion is the root of all evil. Irrational behavior, driven by emotions, is often why people buy at market peaks or sell at market bottoms. Market tops form when all able buyers have been lured in, driven by the Fear of Missing Out (FOMO) mentality, while market bottoms occur when fear has reached its peak and investors capitulate.

Setting investment goals

Setting realistic goals and constraints is key to reducing irrational investing behavior. This vital step not only helps you manage risk but also manage yourself. Emotional decisions are likely to result in financial losses or missed opportunities.

Before making an investment, consider these crucial questions:

1. What is my risk tolerance?

Example: Are you comfortable with high-risk, high-reward investments, or do you prefer more stable, conservative options?

2. What is this investment for?

Example: Are you saving for retirement, a house down payment, or your child’s education?

3. How long is my time horizon?

Example: Do you need the money in 5 years, 20 years, or are you investing for generations?

4. How much loss am I willing to take?

Example: Can you tolerate a 20% drop in your portfolio value without panicking?

5. How much do you expect to make?

Example: Are your return expectations realistic given historical market performance?

Markets movements follow a random walk, with inherent disorder causing change in unexpected and unpredictable ways. There will inevitably be times when strong urges arise, prompting you to make changes to your investment strategy. Reviewing your goals during these moments will help you properly evaluate whether to stay the course or make a shift.

Thou shall not fear cutting losses

Although it may be unacceptable to many, cutting losses is a risk management tool used to reallocate unproductive capital to better investment opportunities. Shifting from one investment outlet to another may involve realizing losses now in exchange for better upside potential later.

Unfortunately, emotions, particularly pride, often keep investors anchored to underperforming investments, preventing them from seizing better opportunities.

Markets generally trend to reflect humans’ desire to follow the herd. What is performing well is expected to continue doing so, as rational investors reduce their exposure to underperforming assets (like a clearance sale) in exchange for those that are thriving (what is “in season”).

Current economic landscape and its impact

Markets are constantly changing, and it is up to us to remain adaptive in order to better position our portfolios for long-term capital growth. Long-term trends are primarily driven by economic conditions and policy actions.

With central banks now providing more clarity on potential rate cuts, the economic landscape for major asset classes is set to shift. Fixed income assets are expected to benefit directly from rate cuts, but tactical opportunities remain on the equity side. The pace of the rate cuts will be crucial in maintaining positive growth while preventing the resurgence of inflation.

Practical tips to avoid emotional investing

1. Keep a trading journal to track your decisions and emotions.

2. Set clear stop-loss and take-profit levels before entering a trade.

3. Diversify your portfolio to spread risk and reduce emotional attachment to any single investment.

4. Regularly review and rebalance your portfolio to maintain your desired asset allocation.

5. Consider using dollar-cost averaging to reduce the impact of market timing and emotional decision-making.

Mastering the art of letting go in investing is crucial for long-term success. By understanding the emotional roots of our investment decisions, setting clear goals, managing risk effectively, and staying informed about market trends, we can make more rational choices and achieve better financial outcomes.

Remember, successful investing is not just about picking the right stocks or timing the market perfectly—it’s about managing your own emotions and behavior in the face of uncertainty. When in doubt, it is best to seek professional guidance to properly steer your investments toward reaching your objectives.

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KYLE TAN, MSFE, CSS is a Portfolio Manager at Metrobank’s Trust Banking Group, managing the bank’s Global Unit Investment Trust Funds (UITF). He holds a Master’s degree in Financial Engineering from the De La Salle University, a Level 3 candidate of the Chartered Market Technician (CMT) certification course and a PSE Certified Securities Specialist (CSS). He spends his free time working out, training at the gun range, or hunting for rare Star Wars collectibles.