by Tyler Curtis
Have you lost sleep over your investments lately? If so you are not alone.
With all the complexities and nondescript jargon surrounding the financial markets nowadays it is easy to forget that they are still driven by the same thing they always have been; buyers and sellers. Each of these buyers or sellers has their own opinion on what the market is going to do next and when. While in the long term stock prices are primarily driven by earnings, in the short to medium term stock prices are greatly controlled by the fear, hope, and greed of stock market participants. In many cases this uncontainable cycle of euphoria and despair is only slightly tied to the business cycle which ultimately controls a given companies earnings potential. An illustration of the investor’s emotional cycle can be seen below.
Anyone who has invested in the stock market before successfully or otherwise can relate to this chart. Investing your hard earned money can be an emotional process; sometimes the swing from euphoria to despair can take years, other times months, and in a volatile investment it may only take a few hours. The emotional side effects of investing can have a detrimental impact on investment performance if they are not first acknowledged and then carefully planned for.
The most common mistake investors make is to buy high and sell low, and it’s easy to see why by observing the above chart. The average investor is eager to invest during the exhilaration and euphoria phases and is fervent to sell everything during the capitulation and despair phase. These are the natural reactions to our emotions when it comes to investing; however when looking back in hindsight they often seem counterintuitive. Many studies have been done to show the affects emotions have on investor results. Most notably, the Dalbar Group has evaluated investor performance over the preceding 20 year period each year since 1984. For example, in the 20 year period ending in 2003, the average stock market timer lost 3.29%. In the same twenty years, the market itself went up an average 12.98% per year.
So how do you avoid succumbing to the emotional roller coaster of investing? The answer is simple: Discipline. One of my favorite quotes by Warren Buffet is: “It is only when you combine sound intellect with emotional discipline that you get rational behavior.” In order to succeed in investing a sound investment game plan must be adopted that addresses each stage of the investing emotional cycle and encourages you to stay disciplined throughout. Without a plan in place many investors are left scrambling when the market moves against them and in that haste make irrational decisions that can have a major impact on their portfolios for many years to come.
Have you ever fallen victim to the emotional effects of investing? Does your current investment strategy have you jumping in and out of the market based on your emotions? If so it may be time to rethink your investments and adopt a strategy that encourages the discipline needed to succeed as a long term investor.