A BMO Psychology of Investing report revealed some worrisome data on investor emotions that included; two-thirds of those polled have not been in total control of their emotions when investing and; a majority of Canadians have invested on impulse at least once.
That’s bad news for portfolios because investor emotions are 180 degrees out of sync with market cycles. At the peak of market cycles, when investors are happiest, they are at maximum risk. Conversely, it is at the bottom of the cycles, when investors are most despondent, that they have the greatest opportunities.
According to a Gerstein Fisher Research Center analytical paper, the average investor’s performance in an asset class lagged the average performance of the asset class itself by an average of one per cent per year over the previous 15 years, based on net investor mutual fund cash flows. Undoubtedly, some of that poor performance would have been due to irrational extremes of hope and fear.
Warren Buffett said it best: “Only when you combine sound intellect with emotional discipline do you get rational behavior.”
In other words, if investors do their research, and don’t let market exuberance rattle them, they are more likely to make sensible investment decisions.
The good news is investor emotions are quite predictable, which means managing them should be possible. It requires two things: a set of rules to guide investment decisions, and the discipline to stick to those rules.
Emotions can be removed from the equation by creating an investment policy statement that sets parameters for making investment decisions, and encourages the discipline required to stick to the rules. Clear rules facilitate a calm assessment of hard facts and ensure proper reactions to new or changing information. Investors remain emotionally neutral, ultimately making them more likely to buy low and sell high.
Rules allow the proper assessment of data and ensure rational responses to new information, such as changes in net assets, revenues, profit margins, debt, dividends and cash flow. Along with expectations for each of these factors, rules should include a margin of safety to allow for unpredictable variables like company earnings.
Kim Inglis, CIM, PFP, FCSI, AIFP is an Investment Advisor & Portfolio Manager with Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp.
