We live in a world which continually exposes us to events that leave us in fear, dread or anxiety. Such events can cause physical harm to yourself or your family or can adversely affect your financial health. In this article, we discuss the differences in these emotional responses as they relate to investments and what you can do to reduce your financial anxiety.

Emotional responses

Fear, dread and anxiety are different emotional responses. Suppose the company in which you have Rs 10 lakh in fixed deposit is on the verge of bankruptcy. The perceived threat of losing money causes “fear”. Now instead, suppose another company in the same industry has filed for bankruptcy due to poor business prospects. You “dread” that the company in which you have your deposits will soon follow suit. Dread is, hence, an expectation of a bad outcome that could lead to fear. Anxiety, on the other hand, is the feeling you have when the nature of the outcome is uncertain. Suppose you invest in shares. You are “anxious” of the outcome, which could be positive or negative.

You will typically face more anxiety than fear or dread in your investment decision, as such outcomes are uncertain. That is, your investment could generate either positive or negative returns. But why be concerned about anxiety?

The reason is that continual anxiety can cause your brain to sound the fear alarm. And this could lead to what is called the fight or the flight response. More often than not, you will choose the flight response. In the case of financial anxiety, it means selling your investments in haste, even if doing so leads to a bad outcome! Anxiety, thus, carries huge cost- emotional stress and lower returns. So, how can you reduce your financial anxiety?

Moderating anxiety

You should focus on your investment objective, not on the returns. When you focus on the returns, your brain is on high-alert, looking at the short-term movements in the market. And the more you look at the market and how your investments have performed, the more you are likely to take the flight response.

Besides, your level of anxiety can be different depending on whether you buy an active fund or an index fund. An index fund gives you anxiety due to uncertain market movements. An active fund adds to the anxiety because you are also exposed to the uncertainty of the portfolio manager’s performance relative to the benchmark index.

Now, if you are past 45 and already have a stressful work life, you should reduce your financial anxiety by investing in products that have stable investment outcomes. That means bonds or more precisely, bank fixed deposits. But fixed deposits cannot generate returns you desire to reach your investment objectives. So, you should invest smaller proportion in high-risk equity funds to compensate for the lower-return fixed deposits. Your overall anxiety levels will be lower because your fixed deposits provide the floor in the event stock market declines sharply.

Finally, adopt a systematic approach, where a specified proportion of your monthly income is automatically routed to desired investment products. Such an approach reduces anxiety because the automatic process distances you from the investment!

Conclusion

Uncertain outcomes are the cause for anxiety. The point is that you do not have control over outcomes that drive your investments’ values. Moreover, higher the returns you desire, higher the uncertainty. This means you have to meaningfully trade-off anxiety and returns. You can do so by setting-up automatic investment processes including pre-determined portfolio rebalancing. And remember this: Whenever you perceive threat to your financial health, adopt the freeze response. That is, do nothing! It is akin to some animals acting dead when they face predators. Your decision-making will be typically better when your fear subsides.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to>knowledge@thehindu.co.in)

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