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The challenge of emotions. How you manage emotions and stay focused can have a significant impact on your financial future.
We believe that investor emotions can play a major part in the success or failure of an investment portfolio as well as the overall wealth plan. For most of us, money is bound up with powerful emotions such as security, confidence and even, sometimes, fear.
But the emotions of investing can cause you to lose focus on important areas of your financial life, most of which have absolutely nothing to do with the stock market.
We know that remaining patient and disciplined can be extremely difficult, especially when stocks or other assets are soaring or plummeting. The way our brains are hard-wired can cause us to make emotional decisions about our money at precisely the wrong moments.
As the Cycle of Market Emotions chart above illustrates, many investors tend to “buy high” and “sell low.” Markets are sometimes prone to sharp and erratic movements, which can precipitate panic and cause investors to sell at inopportune times. Conversely, during a strong bull market, investors often rush into the market because they feel “elated” and buy at the peak.
Ultimately, this kind of emotional, short-term behavior can have detrimental consequences, including dramatic portfolio underperformance.
Moving in and out of markets and asset classes can result in investors missing those relatively small number of days when markets soar unexpectedly. It’s therefore vital that you stick to your plan – especially during periods when the financial markets are behaving in extreme ways.
A 2009 study found that between 1987 and 2009, the average investor did substantially worse than major indices. According to this study, the average equity investor had annual returns of just 3.17%. Over the same period, the S&P 500 returned an annual average of 8.20%. This “behavior gap” of 5.03% (an almost 75% decrease) experienced by the average investor reflects the cost of letting emotions guide investing.
To put this in dollar terms, if you had invested $100,000.00 in the S&P 500 over this period, it would have been worth $483,666.00. However, if you had invested like the average investor in this study, you would only have $186,667.00 at the end of this period. The almost $300,000.00 difference between these two results is a dramatic demonstration of the potential value of patience and discipline. Our prudent investment approach can help you maintain your long-term goals without being derailed by emotional responses to short-term market activity.
Beyond investing, we believe that almost every area of your financial life can benefit from a disciplined, thoughtful approach.
Please note that the fact that buy-and-hold has been a successful strategy in the past does not guarantee that it will continue to be successful in the future.