Investor psychology is an interesting phenomenon. Few of us would say that we are impacted by our emotions. It is more likely that we would say that we are in complete control over our emotions, and would be able to predict exactly how we would act under a range of situations.
While that is what the majority of us would say, the reality is quite different. Financial markets are volatile precisely because human behaviour is unpredictable, and psychologists have employment simply so that we might better understand ourselves.
A more accurate depiction of human behaviour is illustrated in the eastern notion of yin and yang. This symbol shows two swirling, intertwined figures. One is black while the other is white, and each has an element of the other within it. Both are connected, in fact they are two halves of a whole. Positive is connected with negative, dark with light, rational with irrational behaviour, and so on. In fact one would not exist without the other.
Our emotions play a pivotal role in how we view ourselves and our surroundings, as well as how others perceive us, and how their view of us affects us. Our emotions go through swings that create rises and fall in our moods, and inflation or deflation in our lives. It is important to be aware of these swings, and to understand what is happening to cause them.
As a case in point, consider that last August the S&P 500 reach a record high, but by December it had lost a full 20% of its value. The selling was mostly contained through September, October and November, but when December arrived, something triggered investors’ panic buttons. Fear surged and investors began to sell heavily. 15% of the fall experienced during this correction happened in December. December 24th was the worst day of selling. Why?
Why did people sell? There is ample evidence that the S&P 500 has delivered a return of roughly 10% per year for almost 100 years. This return is an average over time, while factoring in years that have delivered considerably higher and lower returns. Warren Buffet, known as the Sage of Omaha, has also repeatedly stated that if an investor is unsure of what to do, then the best course of action would be to buy the S&P 500 and leave it be for the long term.
But despite ample evidence, along with sage advice, investors succumb to their fears and sell, heavily – particularly at the worst time. It is easy to isolate ourselves from the pack and say that we, or I wouldn’t do that. But a lot of people did.
Fear is powerful and contagious. And fear is especially powerful when people don’t fully understand what is going on – financial markets can be complicated, shrouded in opacity, which intensifies fear.
Fear also sells very well. People will be glued to news programs that focus heavily on drama and fear.
But fear eventually runs its course, and people begin to buy again. The buying takes longer than the selling, as fear is very powerful and it takes time to overcome. By the time investors have begun buy, the markets have already rallied and the best opportunities are lost. Consequently, investors often feel burned, discouraged, distrustful, and some vow never to invest in the risky stock markets again. These feelings are completely understandable, especially in the context of investors experiencing volatility or losses with their hard earned money.
Fear is deeply seeded, as is its yin and yang counterpart, greed. These are both core elements in all of us. Both of these sentiments can be traced back to primordial behavior, and maybe even childhood experiences. While we may not be conscious of their origins, when these emotions are triggered our response tends to be instinctive, and very strong. And while some of us are more prepared to understand how, or why we react to these emotions, we are all subject to their vagaries – each of us in varying degrees.
While fear drives panic selling, greed drives investors into asset bubbles, creating crises of a different sort. Fear and greed, or better stated, investor psychology are powerful drivers of the financial markets.
As we break new into new highs for the S&P 500 it is important to realize that 1) the markets and indexes are made up of businesses, and that is what we are ultimately investing in (it’s a market of stocks, not the stock market), and 2) the markets are subject to emotional inflation and deflation.
Investing is a long journey, Mr. Buffett is 87 and still going strong. On this journey we can expect to experience many high and low points, and both will challenge our behaviour in different ways. My role is to be your guide on this journey, to help you through these various challenges, and to keep you on your path to achieving your financial goals, with peace of mind.