“Success in investing doesn’t correlate with I.Q…. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
– Warren Buffet
As Warren Buffet and countless other investment gurus have observed, one of the most important factors for being a successful investor is the ability to control your emotions. While there are numerous analytical tools that can be used to assess the quality, value, cash flow and potential future returns of an investment, they are often trumped in decision making by an investor’s emotions, particularly greed and fear.
Fear of loss is by far the more powerful of the two emotions. In fact, behavioural economists have found in multiple studies that investors view the pain associated with losses as twice as emotionally powerful as the joy experienced from gains. When equity markets drop, investors become more and more risk averse as a result. The aversion is heightened if the drops are meaningful (5%+) and if they happen over a short time period.
The media, while an excellent source for timely details on the economy and company specific information, is also known to sensationalize stories that play on an investor’s emotions. By dramatizing a story, the news source can attain a much larger audience, meaning more clicks, views and interest. Unfortunately, these stirring stories can lead investors to become more emotional and to make bad investment decisions.
During rising markets, stories are often tilted positively to build on an investor’s greed and desire for quick wealth. During down or volatile markets, stories tend to focus on risks and negative factors that play upon investor’s fears. These fears often can lead investors to react by indiscriminately selling their portfolio holdings, regardless of that investor’s goals, needs or even whether the investment is of good quality, offers attractive value or needed income. This indiscriminate selling can result in lower long-term returns and the risk that the investors do not reach their retirement goals.
One recent example was an article on Bloomberg’s website on March 8, 2018 titled “JP Morgan Co-President Sees Possible 40% Correction in Equity Markets”. While the title was factual, it only told part of the story and in this case, the part it did not tell was far more important.
Daniel Pinto, the co-president of JPMorgan stated that within the next 2-3 years, there is likely to be a deep correction in US equity markets of 20-40%, so the headline is factual, but it is nuanced to indicate that the correction is imminent or at least likely to occur in the near-term, not in 2-3 years AND the headline uses the most extreme scenario of a 40% correction vs. the range of 20%-40%. The other element the headline does not include is Pinto’s short-term views, as JPMorgan has generally been positive on the short to medium term prospects for equity markets, i.e. JPMorgan anticipates that the market will rise further prior to a correction. For example, if Pinto sees the market going up 20% in the next two years prior to a correction and the market then drops 20%, the investor’s return is closer to 0% (including dividends earned). A near zero percent return is likely insufficient to meet most investors’ near-term goals, but that is a lot less scary than losing perhaps 40% of their current wealth.
While the headline could incite fear in investors, a more thorough reading of the facts presented in the article should instead yield some caution and reflection. The article highlights that we are in the latter stages of a bull market and due to the low volatility and strong performance of the equity market in late 2016 – early 2018, many investors’ expectations have become too high. During this later stage of a rally, investors should take a breath and reflect to see if their portfolios are in line with their target asset allocations and risk tolerance. It is also a good time for investors to meet with a financial professional to review their goals, cash flow needs, taxes, risk tolerance, time horizon and unique circumstances to create a customized and detailed financial plan and investment policy statement. Investors with formal financial plans and investment policy statements are more likely to stick to those plans and be less swayed by emotions.
Reading a full financial article, not just the headlines, is a good way to uncover useful information for investing. Coupled with a comprehensive financial plan, thoughtfully reading full articles (not just the headlines), is a proven way to control your emotions and to protect your wealth.