The Danger of Emotional Investing

Jeffrey A. Harrell, CFA | Director of Portfolio Management

Two of the most well-known investment phrases are, “you can’t time the market” and “past performance is no guarantee of future results”. Despite the overwhelming number of investors who agree with these statements, when markets experience rapid declines, such as we saw in March of this year, rational thought can sometimes get thrown out the window. Although most investors did not make any material changes to their portfolios, according to various research reports, some did. In a few instances, “get me out”, was the only acceptable solution to seemingly stem the pain. Unfortunately, this short-term solution has now become a long-term problem.

Investors who contacted their advisor wanting to make changes all had similar thoughts. First, they “knew” the market was going to go much lower since the news would continue to get worse. Further, most had every intention of “getting back in” when the market was lower. Ideas ranged from simply waiting on the sidelines for three to six months, to adding 10% back to the portfolio for every 1,000 points the Dow Jones Industrial Average dropped. Unfortunately, the question many investors failed to ask themselves was, “What if the market goes up?”

As everyone reading this is aware, the stock market in fact did go up. From the March 23rd low, the S&P 500 had its best 50-day rally in history. In history!! Those investors who stayed the course have been rewarded, but for those who reacted emotionally, the story is much different.

We have written at length the steps an investor must take to be successful over the long term. Considering the recent volatility, we thought we would summarize them into six points:

  1. Make sure your investment allocation (stock to bond ratio) matches your risk tolerance. This is quite frankly the hallmark of proper investment management and one of the most important decisions we are helping you with. One of our advisors, Herman Freitag, CFP®, recently wrote an article about revaluating this now that the markets have recovered (click here).
  2. Stop watching the financial news channels such as CNBC, Fox Business, or Bloomberg. We routinely comment at our McGill & Hill Group seminars to attendees that the sooner you realize these channels are for “entertainment purposes”, the better investor you will be.
  3. Don’t check your accounts too frequently. Watching your accounts decline as quickly as they did in March is a surefire way to increase your anxiety. Recognize that investing is for the long haul and that daily, weekly, or even monthly account value changes should have no bearing on your investment strategy if you have a solid plan in place.
  4. Turn off the cost basis on your accounts. Over the years, we have taken many calls from clients who solely focus on the losses in their portfolio. Often, they just want to “make the red go away.” This approach can be detrimental to the long-term success of your investment portfolio since volatility is normal when investing in the stock market.
  5. Automate everything. If you are still in your accumulation phase and you had automatic drafts in place, you were able to purchase some stocks at very attractive prices in March. Unfortunately, some investors turned off these automatic investments right when they were most lucrative. Let this be a reminder of why a market decline is the best time to have a systematic investment program in place.
  6. Rebalance your portfolio when stocks drop sharply. We automated this step for you by selling bonds and buying stocks during the downturn to keep your accounts in line with their target allocation. We put together a video earlier in the year that discusses our new rebalancing strategy (click here).

The market volatility we experienced over the past couple of months is like nothing any of us has ever seen and there are absolutely no guarantees that what governments and central banks around the world have done to stem this crisis will result in a quick and long-lasting economic recovery. By the end of the year, it is possible the actions taken will prove to be temporary and darker days may lie ahead. If so, stocks could experience another sharp decline and the fears we all experienced in March may resurface. However, regardless of whether or not the stock market hits a new all-time high in the second half of the year, or drops below the March lows, long-term investors should be prepared to handle either outcome by following the steps listed above.

Have more questions about the dangers of emotional investing? Click here

Past performance is not a guarantee of future investment returns.  Investors cannot invest directly in an unmanaged index.