Proper investing is as much (if not more) about controlling your emotions as it is about understanding everything about the markets and current trends. Facilitating solid, logical decisions should be at the center of every investment strategy.
However, it’s not uncommon for investors—typically those who take a DIY approach—to allow emotions like fear, anxiety, and excitement to drive their investment activity, even without their conscious understanding.
As natural as it is to have emotions about investing, when they take over, it often leads to poor decisions, and thus has the potential for catastrophic long-term financial consequences.
How Does Fear Affect Investing?
One of the most threatening emotions to your portfolio is fear. Fear most often pops up when markets experience a down-turn.
We typically see fear-based investing activity during a bear market (a consistent down-turn over time.) The average investor typically wants to avoid losing money, and will quickly sell off their holdings to “stop the bleeding.”
By panic-selling, they lock-in potential losses and prevent themselves from benefiting from any upcoming market recovery.
Consider this: there have been 24 stock market corrections (a market drop between 10%-20%) since World War II, with the average market dropping by -14.3%. However, the average recovery time is only four months. What's that in comparison to a multi-decade strategy?
What Did You Do in 2008?
During the 2008 financial crisis, many investors saw their 401(k)s and portfolios drop sharply. It was definitely scary.
Many sold their investments at that low point, only to miss out on the subsequent recovery that happened in that next year. Historically, markets have recovered, and investors that stay the course see their portfolios bounce back and grow significantly over time.
The market is cyclical and declines are inevitable, so a portfolio that is prepared for a long-term journey will often see more success.
Anxiety and Investment Decisions
Anxiety is closely related to fear and can also cause an investor to make poor decisions. In volatile market conditions, an anxious investor can find themselves checking their portfolio often, constantly worrying about short-term price fluctuations.
This can lead to making frequent trades in response to minor market changes. Chasing gains and trying to outrun losses can lead to excessive trading, which can lead to tax complications and less-than-optimal investment returns.
The core of a long-term investment strategy is the efficient market theory. You can learn more about it in this episode of the Long-Term Investor from our Chief Investment Officer, but the quick overview is that markets as a whole are taking into account every known variable, and therefore anxiously trying to game it is a relatively futile effort.
This behavior removes the ability to benefit from the long-term growth potential investments have, and typically will result in lower overall returns.
Are You Too Excited in Bull Markets?
So how about when markets are doing awesome? The excitement during these periods of upward market performance can yield equally undesirable outcomes, just like panicking during a bear market.
When markets are booming, an investor often will experience “FOMO” (fear of missing out.) This knee-jerk reaction can cause an investor to feel invincible and start chasing high returns without the proper research or planning.
Excitement often leads to speculative investing in large, concentrated positions in popular sectors, and overconfidence that the markets will continue to move upward. (Example of the Dotcom Bubble below).
As Warren Buffet has wisely suggested, “Be fearful when others are greedy, and be greedy when others are fearful.”
“Technical” Issues
In the late 1990s, there was this little market problem we had called the “Dotcom Bubble.” (To be clear, I'm joking when I say it was little.) Tech stocks were soaring, and it seemed any new tech company that came out was quickly experiencing success.
Many investors poured money into these companies, although they had little to no profits. They simply saw other similar companies growing quickly, and didn’t want to miss out on the next big thing.
Everything seemed to have what looked like endless gains. When the bubble finally burst, these investors had significant losses due to the underlying risks the invested companies had. Most would have benefited from doing more research, or relying on a Wealth Management team that could guide them.
How Do I Keep My Emotions In Check?
So it’s natural but potentially detrimental... how do you stop it? It’s might be helpful to re-frame the question a bit and not try to erase emotions from your financial life entirely, but implement key strategies (i.e. the recipe) to plan for those moments and hedge against letting them control you.
Here’s what I recommend:
Have a Solid Financial Plan
One of the best ways to avoid emotional decision-making is to develop a financial plan and stick to it.
The basics of your plan always start with establishing your goals, risk tolerance, and a time horizon. With a clear plan in place, you’ll be less likely to react emotionally to short-term temptations.
Ask yourself, “Does this fit inside my plan?” If the answer isn’t a hard yes, consider passing on the opportunity. Instead, focus on a big picture and make investment decisions that are aligned with your long-term objectives. After all, you’re investing to achieve goals, and setting a plan that sees your investments as fuel for them in the long-run can help.
Diversification
Diversifying your portfolio across multiple asset classes will help reduce the emotional impact of volatility in the market.
When one sector is underperforming, others may be performing well, which helps build stability and peace-of-mind. A well-diversified portfolio can sustain the ups and downs of the market better than a portfolio concentrated in a single sector or company stock.
Inversely, too much diversification can dilute returns, so consider a Wealth Manager to help you strike a balance.
Focus on the Long Term
Markets will always experience periods of ups and downs, however, over the long-term, markets have historically trended upward.
The problem? That rational mindset is not very exciting in the 24-hour news cycle. By staying diversified and focusing on the long-term growth and the goals you’re trying to fund can help you ignore the noise caused by market fluctuations or trends that push you to make more emotional decisions.
Automate Your Opportunity
Make it easy on yourself. Utilize technology by having part of your income pulled out automatically each month to go to your brokerage accounts or 401(k).
Not only will this help you stick to the plan, it helps eliminate the emotional considerations of what to do, and instead ensures that you are consistently investing without consulting your fear, anxiety, or excitement first.
Work with a Wealth Manager
A trusted Wealth Manager can act as a buffer between you and your emotions. They provide the objective advice you need to help stay on-track when emotions are running high.
A good Wealth Management Team can help create an investment strategy for short-term and long-term goals, and build a deeper level of confidence around your investment and retirement goals.
They can also help you reassess your strategy periodically, ensuring that it remains aligned with your goals while keeping emotions in check.
Take a Deep Breath: It’s All Good
It’s natural for us to experience emotions when investing. It’s just as unnerving to consider our hard-earned dollars quickly disappearing in a bear market as it is addictive to chase the high of a soaring stock position.
But the key to your long-term success is to not allow those emotions to drive your decisions. Fear, anxiety, and excitement can all lead to poor investment choices, and often at the worst possible times.
Stay disciplined, follow a solid financial plan, and team up with a trusted team.
Remember: We can’t control the market conditions that can trigger our emotions, but we can control how we react to them—and therein lies the simple recipe for a successful investor.
