Emotions can play a major role in the success or failure of your investment portfolio, as well as your overall wealth plan. For most of us, money is bound up with powerful emotions such as security, confidence and sometimes even fear. But the emotions of investing can cause you to lose focus on important areas of your financial life. And most of these have absolutely nothing to do with the stock market.
Patience and discipline.
Remaining patient and disciplined can be extremely difficult, especially when stocks or other assets are soaring and plummeting. The way our brains are hard-wired can cause us to make emotional decisions about our money at precisely the wrong moments.
Cycle of Market Emotions
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 start a 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 end up buying at the peak.
The Cost of Emotions
As the chart here shows, a 2009 study found that from 1987 to 2009, the average investor did substantially worse than major indices. How is this so?
According to the study, the average equity investor had annual returns of just 3.17%. Yet, 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 reflect the cost of letting emotions guide investing.
Let’s put this in dollar terms. If you had invested $100,000 in the S&P 500 over this period, it would have made $483,666. However, if you had invested like the average equity investor in this study, you’d only have $186,667. The almost $300,000 difference between these two results is a drastic demonstration of the potential value of patience and discipline.
Beyond investing, at CJM Fiscal Management we believe that almost every area of your financial life can benefit from a disciplined, thoughtful approach. We look forward to discussing this with you in further detail.
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.
“Charlie has a unique quality that you don’t find in most financial advisors. He is dedicated and has sincerity of purpose. He doesn’t just care about the money; he really wants my individual financial position to grow. He wants everything to go well…his emotions are always on my side.”
— He’s a Retired Business Owner
*Average stock investor and average bond investor performances were used from a DALBAR study, Quantitive Analysis of Investor Behavior (QIB), 03/2010. QAIB calculates investor returns as the change in assets after excluding sales, redemptions, and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses, and any other costs. After calculating investor returns in dollar terms (above), two percentages are calculated: Total investor return rate for the period and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptrions and exchanges for the period. 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.