Emotion-Free Investing

Illustration by Ed Nacional (source photo for coin dollar-istock)

We've all been riding an emotional roller coaster lately, watching the markets zoom up and down with no relief in sight. Who could blame even the steeliest investor for losing her cool last week as recession fears sent the Dow tumbling 391 points in one afternoon? Economists are talking about a double-dip recession. Congress is gridlocked again.

But just as you should never go to bed angry, experts will tell you to keep calm when it comes to your finances. "We've gotten better control of our emotions because we've experienced recoveries," says Louis Harvey, CEO and founder of the market-research company Dalbar. But with all the tumult these days, it can be tough to be clear-minded and dispassionate about money all the time. Here are a few techniques to help you invest with your head, not your heart:

Know where specific emotions are likely to lead. Harvard University professor Jennifer Lerner, who is also director of the Harvard Decision Science Laboratory, says anger makes people optimistic and risk-seeking, while fear makes them pessimistic and risk-averse. Sadness makes people eager to buy things; disgust makes them unlikely to want to buy anything at all; both make them likely to sell on the cheap things they already have. "When you're sad, you're trying to change your circumstances," says Lerner. "When you're disgusted, you're trying to cleanse." All these feelings are detrimental when making investing calls.

Justify your actions to someone else. It's one thing to know how feeling sad or disgusted affects your spending; it's another entirely to feel accountable to another person. That could be a spouse, a financial planner, or someone else you trust—anyone who can act as a dispassionate counterpoint to emotional decision making. "It doesn't reduce what people feel," Lerner explains, but having a person like this in one's life "alters whether they use that feeling in making their decisions."

Stick to a plan. Human beings are, well, human, and that's why we all need a financial plan to keep us honest when emotions take hold. Financial adviser Carl Richards, author of the upcoming book Behavior Gap, says a plan will help you step back for a minute and, instead of reacting impulsively to market conditions or other personal setbacks, "ask yourself: Why'd we make this decision? Have the goals changed? Has life changed?" If they haven't, maybe now isn't a time to make a change after all.

Emotion-Free Investing | Business