It’s best to rely on facts, not your mood when investing
March 19, 2015
Compelling proof suggests you call your psychotherapist and not your investment advisor before you make investment decisions.
Evidence puts forward the idea that your returns are based on your mood instead of investment logic.
How is this possible? We know that the markets go up and down. It is these highs and lows that provide you with gains or losses.
However true this may be, your mood dictates whether you are a buyer or seller. It has nothing to do with the market itself.
We have known this for some time and in that regard nothing has changed. What is new is another study we have that reiterates the lessons we have learned from other similar studies.
The investment firm BlackRock completed as study titled “Investing and Emotions”. Their data is based on the American market as measured by the S&P 500 index.
The market returned an average annual rate of return of 8.2 per cent during the period 1992 to 2011. During that same time the average investor only earned 2.3 per cent.
Even the poorest or unluckiest investor should be able to capture more of the market returns than the average American investor. This appears, however, not to be the case.
The culprit is the human mind. When the market appreciates in value investors are confident and they continue investing.
The opposite is also true. When the market declines investors are hesitant and that caution means they do not invest.
The popular investing expression of “buy low and sell high” is great in theory. In reality it has no practical application because of the way the human mind responds to market fluctuations.
It is almost better if after you invested, you forgot you had invested. That way you would not let your volatile human emotions manage your investments.
As it turns out we have concrete information that supports the importance of not allowing human emotions to torpedo your investment returns. This comes from one of the biggest investment firms in United States.
Fidelity analysts reported that investors who had forgotten they had an account with their firm outperformed other accounts. In other words, those who did not remember their investments could not use their own version of market timing to interfere with performance.
Financial planners have been suggesting a buy and hold strategy that tries to negate the adverse impact of the emotion-driven buy and sell decisions.
Markets do fine in the long term; however, unfortunately individual investors don’t. There is another strategy.
Warren Buffett is one of the most senior and respected investors in the U.S. He says “Be greedy when others are fearful and fearful when others are greedy.”
His approach is to go against the crowd and buy or sell when the investment mood is opposite.
Our suggestion is to understand that there is risk when you invest. It is advisable not to add to that risk by investing based on your potentially irrational behavior.
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