How Emotional Intelligence Improves Investment Performance

Did you ever feel your stomach drop when investing plunged? You know that feeling of excitement you get when they go up? You're not the only person who feels this way. These powerful emotions can ruin the best-laid investment plans.

Let's discuss why your brain behaves in this manner and, more importantly, what you can do to maintain your calmness when the markets become crazy. - Learn more about Affirm Wealth Advisors

Why Your brain can sabotage Your investments

Your relationship with money isn't just about numbers--it's deeply personal, shaped by your entire life experience.

The hidden forces behind your financial decision-making

You're sure you make rational financial decisions? You may be mistaken. The majority of financial decisions are subconscious.

• The brain feels losses more intensely (losing $1000 feels worse than winning $1000 feels good).
• Market crashes are now more real than ever before thanks to the evolution of wiring
• Fear and greed influence more investment decisions compared to logical analysis

Your financial future is shaped by the past.

Remember how your parents talked about money when you were growing up? The early financial lessons you learned still affect how you react today to market changes.

• Early experiences with money can form neural pathways lasting decades
• Market crashes have left us with a persistent bias
• Risk tolerance is influenced more by your personal financial history than any other finance class

Why Knowing better doesn't necessarily mean doing better

Even though you may know exactly what to invest in, it doesn't mean you'll follow through. This explains why even financial experts make irrational choices when emotions run high:

• Market panic can override rational thinking in seconds
• Knowledge gaps are costly to investors, but implementation gaps are more expensive.
• Only information alone can rarely change deep-seated financial behaviours

Behavioral Finance, The Science Behind Market Madness

The assumption of traditional economics was that all investors were rational. The behavioral finance approach reveals the emotional factors that drive market fluctuations.

From Rational Theory towards Emotional Reality

The field was born when researchers began noticing patterns of irrational and unsustainable financial behavior.

• Classical economists cannot explain why markets always overreact
• In the 1970s, Kahneman Tversky and other psychologists revolutionized our understanding.
• The 2008 financial crash pushed behavioral financing into the mainstream

Why Markets aren't Always Rational

Markets are not perfectly efficient, despite what textbooks claim. Human psychology creates persistent inefficiencies:

• Emotional reactions frequently cause assets to be mispriced
• Investor herding generates boom-bust cycles that transcend fundamental values
• Psychological factors explain why bubbles form and markets crash

Key Investment Principles That Every Investor Should Know

When emotions cloud your judgement, you can recognize them by understanding these concepts.

• Loss aversion is a phenomenon where losses hurt about twice as bad as similar gains.
• Recency bias: Giving too much weight to whatever happened most recently
• The anchoring effect: Decisions are tied to random points of reference, not fundamentals

The emotional investing traps we all fall into

The brain is full of shortcuts. These helped our ancestors to survive, but they can ruin your investment returns. We'll identify these biases to help you overcome them.

Fear-Based Mistakes That Cost You Money

Fear of losing money is more common than other emotions.

• Loss aversion makes you sell winners too early and hold losers too long
• The risk-averse attitude increases when the opportunities are at their greatest
• Catastrophizing results in excessive cash positions which are slowly eroded by inflation

When Greed Drives the Wheel

You can be tempted to take excessive risk during bull markets by your optimism bias.

• Overconfidence can lead you to overestimate and underestimate your abilities, as well as risks.
• FOMO (fear of missing out) drives you to chase performance in hot sectors
• Selective memory helps you forget past mistakes during market euphoria

Cognitive Blind Spots That Every Investor Has

You are constantly seeking information to confirm what you already think.

• Confirmation Bias leads you to ignore warnings signs in investments that are dear to you
• Mental accounting is inconsistent in risk approach across different accounts
• Sunk Cost Fallacy: You are stuck with losing strategies because of "you have already invested so many dollars"

The Four Market Cycles, and Their Emotional Rolling Coaster

Markets move in psychological cycles as predictable as their price patterns. Knowing which emotional stage is the market in can give you a tremendous advantage.

Bull Market Psychology: The Dangerous Path to Euphoria

Bull markets tend to follow an emotional progression that is predictable:

• Early optimism opens up solid opportunities for reasonable pricing
• Middle appreciation builds confidence but increases complacency
• As rational analysis is ignored, the euphoria signal danger

Bear Market Psychology: From Denial to Opportunity

Bear markets are a predictable source of emotional reactions.

• Investors are unable to accept the decline of markets and continue to hold their full investment.
• Fear of losses prompts widespread sales
• The greatest opportunities are created when the maximum level of pessimism is reached.

The psychology of market turn-points

Investor psychology plays a major role in the market's transition, before it affects prices.

• Excessive optimism often signals market tops before prices actually peak
• Widespread capitulation usually precedes the bottom of the market
• Price movements are often preceded by sentiment indicators that lead to price changes in weeks or even months

How to deal with your emotions in a market turmoil

It is possible to learn how to manage your emotional response when the market fluctuates. Try these techniques to stay rational when markets get turbulent.

Mindfulness Practices that Improve Investment Decisions

Developing awareness of your emotional reactions creates space for more rational decisions:

• Regular meditation improves emotional regulation during market stress
• Body scanning is an easy way to identify whether anxiety is affecting you.
• Reaction intensity is reduced by emotional labeling ("I am feeling afraid right now")

Why Investment Journaling will Transform your Results

This simple technique dramatically improves the quality of your decisions:

• Investment journals are objective documents that record your thoughts.
• Tracking emotions alongside decisions reveals harmful patterns
• Regular reflection increases your awareness of personal financial triggers

Psychological Distance is a powerful tool

By viewing the market volatility with a detached view, emotional reactivity is reduced:

• Imagine you're giving advice to another person instead of your own self
• Consider decisions in the third person ("What should Jane decide?").
• Visualize the future you to prioritise long-term success over short term emotions

Building a strategy for investing that is in line with your psychology

The best strategy for investing takes into account your psychological tendencies. Aligning the approach to your emotional realities can improve long-term results.

Rules-Based Investing: Your Emotional Circuit Breaker

The emotional aspect of investing can be avoided by establishing clear rules for investment in advance.

• Pre-commitment strategies prevent impulsive decisions during volatility
• Rebalancing Rules Force Contrarian Behavior When Emotions Resist
• Systematic investment plans eliminate timing decisions entirely

Finding Your Sleep at Nigh Factor

You can stay invested in the market even when it is turbulent with the right position size.

• Positions small enough to prevent panic selling during downturns
• Diversification decreases emotional attachment towards individual investments
• Risk management rules prevent catastrophic losses that trigger abandonment

Matching Time Horizons to Emotional Capacity

Different time horizons require different psychological approaches:

• Longer time frames reduce emotional reactivity in response to short-term volatility
• Diverse strategies with different goals enhance overall stability
• Prepare mentally for volatility to reduce surprise reactions

Social Psychology: The Social Side of Market Psychology

The markets are social institutions, where the psychology of collective behavior drives price changes. Understanding these dynamics allows you to resist unhealthy social pressures.

Why We Can't Help Following the Herd

Humans evolved to be a group-following species for safety.

• Investors attracted by social proof are more likely to invest in popular stocks near the market's top.
• Markets overshoot on both sides because of herding
• When herding behavior is extreme, there are many opportunities for contrarian thinking

Media Narratives: How they Influence Market Movements

Financial media amplifies emotional extremes through compelling stories:

• Reporting on the market is always a follower, not a leader.
• Media narratives simplify complex dynamics to dramatic storylines
• Headlines are more emotional during periods of market stress

Thinking Independently When Everyone Agrees

It is important to have the courage to think for yourself.

• Cultivate a diverse information diet to reduce narrative capture
• Look for negative evidence to confirm your investment hypotheses
• Market extremes are best suited for contrarian thinking

Creating a Healthier Relationship With Money

Your overall relationship with money will shape your investing experiences. Clarifying your money philosophy improves decision quality during market swings.

Redefining Wealth Your Way

Wealth can mean different things to different individuals.

• Financial freedom is more satisfying than pure accumulation
• Understanding your "enoughness" can reduce harmful comparisons
• Control over your time often matters more than absolute wealth

Align Your Money With Values

Investment decisions reflect your deeper values:

• Value-aligned investments reduce cognitive dissonance during volatility
• When markets are turbulent, personal purpose can provide stability
• Ethics can help to increase commitment towards long-term strategic goals

Find the Balance between Today and Tomorrow

Money serves current needs as well as future goals.

• Over-saving might create unnecessary present sacrifice
• Saving too little can cause anxiety in the future, which reduces your enjoyment of today.
• Individual circumstances and values will determine your personal balance point

The Emotional Health Management System: Your Action Plan

Implementing theory makes it valuable. Let's personalize our approach to managing emotions.

How to Develop your Investor Policy Statement

When the market is turbulent, a written investment policy statement can be a reliable reference.

• Document your investment philosophy in advance of market stress
• Include specific guidelines for actions during market extremes
• Review and modify your plan annually to maintain consistency.

Create Your Own Circuit breakers

Predetermined pause points prevent reactive decisions during high-emotion periods:

• Mandatory waiting periods before making significant portfolio changes
• Asset allocation limits that limit maximum adjustments
• During emotional times, trusted advisors can provide perspective.

Turn every market cycle in to a learning experience

Systematic review turns market experiences into valuable learning:

• Reviewing after-action videos reveals emotional patterns
• Instead of focusing on outcomes, focus more on the process.
• Small improvements compound over an investing lifetime

The Bottom line: Your psychology will determine your edge

Your greatest investment advantage comes from managing your emotions. While you may not be able to control the markets themselves, you are able to control how you respond. That is probably the most valuable skill in investing.

What emotional investment traps have fallen into you? How do you manage your emotions during times of market volatility? Share your experience in the comments section!