Emotional Investing:

Don’t Let It Get In The Way of Your Long Term Plan

Watching the value of your investments fluctuate can be an emotional experience. When markets are falling and your investments decrease in value, you may worry about the impact this will have on your overall financial well-being. When markets are climbing, you may become excited and over-confident, willing to take on additional risk to see your assets grow further. All of these emotions are entirely understandable, but reacting based on these emotions can be detrimental to reaching your investment goals.


During periods of heightened emotions, decisions tend to be based on short-term objectives, without much consideration for their long-term implications. While it may be difficult to watch the value of your portfolio decline, it may be even more difficult to recover from a series of poorly timed decisions. Remaining calm during all market environments and staying focused on the long term is critical to reaching your financial goals.


Emotions can prove costly – When shopping, most consumers prefer to look for deals on goods and aim to pay the lowest price possible. Yet, when it comes to investing, many consumers consistently pay higher prices and avoid the opportunity to pay lower prices. The chart to the right shows a positive relationship between equity mutual fund sales and equity market performance. As equity markets were soaring during the tech bubble of 1999/2000, so were equity fund sales. And following the financial crisis of 2008/09 when equity markets tumbled, Canadians redeemed their equity funds. The problem is that investors are consistently buying high and selling low, a situation that can lead to disappointing portfolio performance over the long term.


A study by DALBAR, a leading financial services market research firm, found that the average annual return for an equity mutual fund investor over the 20-year period ending December 2017 was 5.29%. This compares to the S&P 500 Index, which returned 7.2% per year over the same period. The study concluded that underperformance was mostly explained by emotional reactions during periods of market stress, resulting in poor timing decisions. After 20 years, this underperformance would have resulted in a difference of over $120,000 on an initial investment of $100,000.


Controlling your emotions – Remaining calm during all market environments and staying focused is critical to reaching your goals. Here are a few suggestions:


Ask big picture questions – There are reasons why you began investing in the first place, which in turn helped determine how your portfolio is constructed. It may be helpful to revisit these goals when volatility picks up to see if anything has changed. If you’ve answered “yes” to any of the questions to the right, then ask yourself why you need to make any changes, particularly knowing the risks involved in getting it wrong. If the only thing that has changed is the short-term value of your portfolio, should this affect your long-term plan? These bigger picture questions can help shift the focus away from the short-term discomfort. However, if the answer to any of the questions is “no,” discuss these changes with your advisor as they will review and work with you to adjust your investment plan.


Tune out the headlines – A major source of uncertainty comes from the media, where the focus tends to be negative and sometimes alarmist. It is extremely difficult for forecasters to accurately predict where markets will go in the short term and no forecaster has insight into your unique situation.Watching the news and reading headlines will only serve to heighten your anxiety during difficult times and increase the chance that you’ll react emotionally.


Stop constantly checking your investments – Are you guilty of obsessively checking your portfolio on a daily basis? One way to reduce the emotional impact of market volatility is simply looking at it less often. The market tends to be more volatile over shorter time periods, so the more often you check, the greater the likelihood you’ll see wider fluctuations in the value of your portfolio. Checking your portfolio monthly, quarterly or even yearly means you’re more likely to see trends over the long term.


Speak with an advisor – Many advisors have been through multiple market cycles and have seen difficult periods before. Having an objective advisor who can share their expertise and experience to provide you with advice during difficult times can be extremely important in keeping your plan on track.


Thinking about taking a break?  If you are nervous about market volatility and are thinking about moving your investments to cash, it is important to understand that doing so will introduce several new risks to your portfolio. While moving to cash may feel safe, remaining in cash for an extended period of time ultimately erodes your purchasing power. Even at a modest inflation rate of 2%, you will lose 10% of your purchasing power over a five-year period. Inflation is a serious threat to your long-term plan, but it’s less obvious because the face value of your assets don’t decline.


Keep your emotions in check – Reacting emotionally often complicates the investment process and the more you try to time the markets, the worse off you are likely to be. Investment plans shouldn’t be derailed by uncertainty and periods of volatility. Make sure to sit down with an advisor on a regular basis to review your risk tolerance, time horizon and objectives to ensure your plan is appropriate so that you can remain on track.


Susan Gottlieb is Vice President and Wealth Advisor with RBC Dominion Securities Inc. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. susan.gottlieb@rbc.com




Categories: Financial Wellness & Advice