With summer right around the corner, you could be planning a trip to your favorite amusement park. Once there, you might even be brave enough to ride one of the giant roller coasters that are so popular at many parks today.
Amusement park roller coasters are fun — at least they are for some people. But the emotional roller coaster that some investors find themselves on as they follow the daily ups and downs of the financial markets? Not so much.
Unhealthy for Your Finances
Riding the investing emotional roller coaster isn’t healthy for your physical or mental state or for your finances. On the financial side, making investing decisions based on emotions can lead to poor long-term returns. For example, when the markets fall, fear can prompt investors to sell securities when prices are low. Then when the markets rise, greed kicks in and some investors end up buying securities when prices are high.
Often, the result of making emotional investing decisions like these is that investors end up buying high and selling low. Of course, this is the opposite of a profitable investing strategy.
Unfortunately, the 24-7 news culture we live in tends to reinforce emotional decision-making among investors. We are exposed to investing and financial news today on a non-stop basis, such as financial websites that report minute-by-minute stock prices and talking heads on TV telling everyone how to invest their money.
But these supposed experts don’t know anything about your financial situation or goals. In fact, these programs often benefit from higher ratings when they stir up emotions among investors — for example, by sowing fear during market drops and excitement when the market is rising.
Backed by Research
Research has quantified the negative impact of making emotional investing decisions on portfolio returns. For example, the DALBAR Quantitative Analysis of Investor Behavior study measures the effects of investors’ decisions to actively buy and sell securities and switch into and out of mutual funds.
According to the most recent DALBAR study, poor timing of investment decisions resulted in a loss of 9.42% for the average investor in 2018. In comparison, the S&P 500 Index lost about half this much last year, or 4.38%.
Interestingly, the average investor underperformed the S&P 500 Index last year during both up and down markets. In October, which was a down month for stocks, the average investor underperformed the S&P 500 by 113 basis points. And in August, which was a good month for stocks, the average investor underperformed the S&P 500 by 146 basis points.
A DALBAR spokesperson explained the results this way: “Investors sensed danger in the markets and decreased their exposure but not nearly enough to prevent serious losses. Unfortunately, the problem was compounded by being out of the market during the recovery months. As a result, equity investors gained no alpha, and in fact trailed the S&P by 504 basis points.”
Jumping off the Roller Coaster
Here are 3 suggestions to help you jump off the investing emotional roller coaster once and for all:
- Stay focused on your investing goals. If your primary investing goal is to build up a retirement nest egg over the long term, then the short-term gyrations in the stock market will likely have little impact on your ability to reach this goal.
- Don’t pay too much attention to the financial media. If watching the non-stop media market coverage tempts you to make emotional investing decisions, turn off the media. This can be especially helpful when the markets are volatile.
- Communicate with your financial advisor. Unlike the talking heads on cable TV or online, your financial advisor is intimately aware of your financial situation — including your investing goals and your level of risk tolerance. If you feel tempted to make an emotional investing decision, talk to your advisor first about whether this decision is in your long-term best interest.
Feel free to give us a call for more guidance when it comes to getting off the emotional investing roller coaster.
