If you’re feeling pretty uncomfortable about the current state of financial markets you can be reassured that you’re not alone. Almost all investors are experiencing some discomfort from the recent falls in asset values, yet some handle it better than others.

How you manage your emotions in relation to the market’s volatility can have a big influence on your investment outcome over the long term.

In this article we explore the influence of our emotions on financial decisions and look at what we can do in times like these.

Our emotions are fundamental in the decision making process and influence our behaviour, thoughts and actions. Understanding our emotions and learning to manage them can improve our overall investment experience.

According to studies by behavioural scientists[1], our feelings make us focus on information that matches our mood. So, for example, if the market is trending upwards, and your mood is positive, you would tend to focus on information that confirms these emotions, (as was probably the case throughout the first half of last year). Conversely, we are more likely to be influenced (unconsciously) by information that is negative in the current climate.

Our feelings also influence what information we retrieve from our memories. For example, if you are in a positive frame of mind, you are more likely to focus on positive possibilities. Given the current sentiment, we can assume that most people are currently focusing on negative possibilities.

These reactions can spiral and feed off themselves. Once a market starts to rise, our mood improves – our focus shifts to positive possibilities and positive news. As a result, our mood improves further, which in turn focuses our attention on more positive news and even more positive possibilities. If our emotions can spiral, upwards or downwards, then our emotional projection of the future possibilities for market prices can end up being either euphoric or cataclysmic.

With the benefit of hindsight, it is apparent that most market highs are experienced when emotions were excessively optimistic and market lows experienced when emotions were excessively pessimistic. Based on this observation, investing when you feel optimistic and selling when you feel pessimistic is unlikely to prove a smart investment strategy.

Yet emotions do have their place in the decision making process. As one behaviouralist noted, "if you were a small animal faced with a bobcat and had to make a deliberate decision about what to do, you would have to consider the likelihood of each possible choice succeeding or failing and could get so bogged down in decision making that you would be eaten before you made the choice".

However, financial decision making is not of a life and death nature, (even though it may feel like it sometimes). Our emotions help us take action and avoid procrastination, yet we need to temper them to avoid being reactive and falling hostage to them. Instead, our aim is to balance the emotive need to act with our long term requirement to make smart financial decisions. You can do this by "stepping back" and reappraising the situation from a more rational and unemotive perspective.

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