Personal Finance

Balancing the emotional and the rational

B Venkatesh | Updated on April 14, 2019 Published on April 14, 2019

Spouses must calibrate investment choices based on both their biases

We recently had an interesting conversation with an individual who has done reasonably well, self-managing his personal investments. He had a problem, though. He bought stocks when he believed the market had declined enough to offer reasonable valuation.

The problem was that the funds for his trading account came from savings that were earmarked for buying a house. He wanted a solution to help him stop diverting funds. You may be facing a similar issue. We discuss the process to moderate your desire to divert earmarked-savings to your trading account.

Brain-friendly framework

You have to understand your brain to appreciate why you or your spouse suffers from such a temptation. You have two primary brain systems that influence how you respond to money — the limbic system and the prefrontal cortex.

Suffice it to mean that the limbic system is the emotional brain while the prefrontal cortex is the rational brain.

Your rational brain tires easily. And your emotional brain forces you to yield to temptation whenever your rational brain is tired.

Remember the time you scarfed down a couple of sugary doughnuts despite your strict diet?

It would have most likely happened after your rational brain became tired from a hard day’s work. It is no different when it comes to your financial decisions. You are likely to yield to temptation to trade in the market when your rational brain is tired. And that is not all.

Some individuals are genetically predisposed to being more emotional than others. Maybe you are. Or, perhaps, your spouse is.

That is why you should adopt a brain-friendly framework to investing. You should create two portfolios — a rational one and an emotional one — to sync with the two brain systems. The rational portfolio is an accumulation portfolio mapped to your life goals, with systematic investments.

This portfolio will contain two asset classes— equity and bonds. You can invest in an equity fund and bank deposits to fulfil your exposure to these two asset classes.

The emotional portfolio will enable you to capture gains from short-term fluctuations in the market. The idea is to create a portfolio that you can use to yield to temptations. But how can you ensure that you do not divert money from the rational to the emotional portfolio?

Moderating temptation

The spouse who is more emotional should manage the emotional portfolio, so that the urge to trade is satisfied and he/she is not tempted to divert funds from the rational portfolio.

Creating the rational portfolio requires more deliberation. After all, this portfolio is set up to help you achieve your life goals such as buying a house and saving for retirement. So, you and your spouse should discuss about the investments required for this portfolio, together.

Based on the deliberations, systematic investment plans (SIP) on equity funds and recurring deposits with banks should be set up. The spouse who is more rational should control the rational portfolio.

Do not allocate more than 30 per cent of your total investments to the emotional portfolio.

More than diverting funds, it is losses that you incur in your trading account that are of concern.

The writer is founder of Navera Consulting. Send your feedback to portfolioideas

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