Behavioural Finance: Navigating the Risks of Emotional Investing

Emotions are a significant part of everyday life, impacting many decisions we make. With respect to investing, it is important to understand the emotional decisions we are faced with and how our response can have an impact on overall investment success.

Investors who stayed invested for the long term, through good times and bad, prospered.1

As we enter a period of economic uncertainty with continued market volatility, global trade wars and frequent headlines relating to recession indicators, the topic of emotional investing is increasingly important. 

Compounding the market noise is the fact that we are in the late stages of a historic period of growth - 122 months (the longest economic expansion in American history2) - which means investors haven't been faced with the same levels of uncertainty in recent years.  

Emotions are a significant part of everyday life, impacting many decisions we make. With respect to investing, it is important to understand the emotional decisions we are faced with and how our response can have an impact on overall investment success.

The two main factors we consider when assessing emotional investing are: fear and greed. An investors 'Sensitivity to Noise' – a known investing blind spot - can enhance these emotions.

When markets are performing well, investors are more confident and more inclined to enter the market, at a higher price. Conversely when markets are lower, investors may sell, for fear of further losses.

Allowing investment decisions to be driven by such emotions can lead investors to buy and sell at inopportune times, which can have a significant impact on overall returns, as depicted below.

If we set aside the fear and greed emotions, in reality "we can see that markets rebounded from negative factors impacting their performance, and eventually surpassed their previous highs"1, as depicted in the chart below.

Take for instance the latest recessionary period in recent history, which was driven by the 2008 global financial crisis. The recovery from crisis-era lows kicked off the longest bull run in market history – 10 years.

The S&P 500's closing price on March 9th, 2009 (financial crisis low) was 676.53. On October 9th, 2019, the S&P 500 closed at 2,919.40. That represents around a 330% rise in a 10-year period.3

It is human nature to react to volatility, which can prove challenging in remaining committed to a disciplined long-term investment strategy. Although challenging, successful investment portfolios are built on long-term investment strategies. 

The proof is in the analysis - "by staying fully invested and not missing the strongest 20 investment days over the last 20 years, an investor would potentially have more than doubled their investment."4

Manulife Investments (2019), Five Timeless Principles for Investing Success

Understanding and monitoring your emotions is an important step in the decision-making process. Working with an investment professional, who can provide an educated and objective view of the market, can help reduce the impact of emotional investing. 

An investment professional can help you to develop and, most importantly, adhere to a detailed investment/wealth plan. They can also help you to understand the consequences of not developing and adhering to an appropriate plan – leading to a variety of emotions.

1 TD Asset Management (2019), The Risks of Emotional Investing and How to Avoid Them
2 Brad Simpson (September 2019), Monthly Perspectives, The Final Act
3 Chen, James (2019), Market Milestones as the Bull Market Turns 10
4 Manulife Investments (2019), Five Timeless Principles for Investing Success
The information contained herein has been provided by Julie Fitzpatrick and is for information purposes only. The information has been drawn from sources believed to be reliable. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual's objectives and risk tolerance.
Index returns are shown for comparative purposes only. Indexes are unmanaged, and their returns do not include any sales charges or fees as such costs would lower performance. It is not possible to invest directly in an index.
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About the Author

Julie Fitzpatrick, CPA, CA

Investment Advisor, TD Wealth Management
Julie Fitzpatrick is an Investment Advisor with TD Wealth Management in Saint John. She obtained her Chartered Accountant (CA) designation in 2012, placing on the David Hope Honour Roll, and holds a Bachelor's degree in Business from the University of New Brunswick Saint John, graduating with the Lieutenant-Governor's medal for distinction in scholarship. At TD Wealth, Julie works with clients to prepare personalized and comprehensive wealth and investment plans to help comfortably meet their goals.