Investing, you, and your emotions – here are the issues
As much as we’d like to think that our decisions are based on 100% logic, the growing field of behavioural finance suggests that investors are influenced by a variety of subconscious biases, expectations, and emotions. Often, the results can be less than desirable.
“When education members make investment decisions based on their emotions, they can fall short of important long-term goals like making sure they have enough income to support their retirement − which is often longer than people in other professions,” says Matthew Dang, Educators Senior Financial Advisor. “It’s important that they work with their financial advisors to understand the reasons behind, and the impact of, the decisions they make.”
The impact of emotional investing
Generally speaking, consumers prefer to get the highest value for the goods they buy. However, the history of equity mutual funds suggests that when it comes to investing, many Canadians actually buy high and sell low…and that it may be due to emotional investing.
From 1999 to 2000, equity mutual fund sales were soaring. But during the financial crisis of 2008-2009, Canadians sold off their equity funds, refusing to take advantage of the tumbling prices. The result? The average annual return for an equity mutual fund investor ending in 2015 was 3.1% lower than the Standard & Poor’s 500 Index in the same period. One study concluded this was a direct result of poor timing, caused by emotional reactions during periods of market stress.
Are hidden emotions and biases influencing your investment decisions?
Here are some of the assumptions, biases, and emotions that behavioural finance has identified as having a negative effect on investors’ decisions:
Recency bias – after a long bull run by the market, investors may develop a subconscious expectation that the market will continue to go up indefinitely. (Kind of like assuming that, because a student has always gotten good marks, they always will.) Because they haven’t experienced a substantial decline recently, they could also have an unrealistic assessment of how comfortable they are with risk. One solution? Assess how your portfolio would have done during a period of market decline, such as that of October 2008.
Availability bias – this is when the news you’ve read most recently impacts your decision to an inappropriate degree. If you have not read enough to have a balanced view of a situation, your decisions may be overly influenced by the news available to you.
Loss aversion – psychologists have shown that the pain experienced when investments decline in value is greater than the pleasure experienced when they go up. In these cases, the mere possibility that the market might decline can cause investors to sell prematurely.
Herd mentality – this occurs when investors feel safer investing in a company or sector because they see and hear that others are doing it.
Anchoring – this is the tendency to think that an investment’s previous price, or initial purchase price, should be its norm.
Avoiding emotional investing: the do’s and don’ts
Just as every education member has different career objectives, every investor will have different attitudes, emotions, and triggers. Understanding the unique things that influence you is key. However, there are some general rules of thumb that can apply to everyone.
To avoid emotional investing and the potential negative impact on your portfolio, DO:
- Increase your financial literacy, specifically around investing. Understand that the stock market, by its very nature, has ups and downs. (There are many resources in The Learning Centre that can help you understand market volatility.) Have frank discussions about your investment objectives and time horizon with your financial advisor.
- Take your time when making decisions (a.k.a avoid trying to “time the market”). Decisions should be based on balanced information about each investment, as well as the role it will play in your portfolio.
- Be honest with yourself about yourself. There’s a saying, “Physician, heal thyself.” For investors, this expression should be “Investor, know thyself”, particularly when it comes to your tolerance for risk. How comfortable are you with investments that have the potential to increase quickly … but also decrease in value just as fast? Are you just starting out in your education career, only able to contribute small amounts, but on a regular basis? Or are you approaching your 85 or 90 factor and looking to contribute more (but with less time to ride out the normal market corrections that occur over time)? Learn more about how to build a portfolio that reflects your risk tolerance.
Tip: Find yourself in a situation with less funds to invest? A Pre-Authorized Contribution Plan (PAC) can start with as little as $25 a month. - Most important – find a professional you trust and can work with. The experts at Educators Financial Group have specialized training and years of experience working with the education community. Whether you’re They’re dedicated to ensuring your investments meet your unique needs (like making sure your Registered Retirement Savings Plan works with your pension)!
The list of “DON’TS” is shorter. In your attempts to reduce the potential of emotional investing, resist taking a break from investing. Reacting to market volatility emotionally, becoming nervous, and moving your investments to cash could expose you to inflation risk. This is because remaining in cash for an extended period of time will erode your purchasing power. Even a small inflation rate of 2% can mean significantly less purchasing power within a few years.
Wondering about the stock market, and how to invest to meet your goals? A Financial Planner professional or Senior Financial Advisor at Educators Financial Group can answer all your questions. Get started online or give us a call today.
Sources:
https://ca.rbcwealthmanagement.com/documents/346993/0/emotional-investing.pdf/975b7ea8-4262-4cc2-b8b3-9f5d2f54c2cf
