In the next few days, many investors are going to see their quarterly performance reports for 3Q of 2015. While we financial planners would hope that it would be only a trivial matter, as investing is a long-term game to be measured in years, some investors are going to predictably exhibit some of the following behaviors: panic, anger, fear, uncertainty, and doubt. It’s unavoidable, and to a degree, it is science.
According to noted behavioral economics experts Daniel Kahneman and Amos Tversky, individuals have a strong aversion to losses when risk is constant and present. They maintain that people weigh losses about twice as much as gains of equal size. For example, a loss of $1000 is about 2 times more painful for investors than a gain of $1000. Now, this doesn’t sound rational, and by standard economic models, it’s not rational. However, history has proven over and over again that we are definitely not rational when it comes to our money.
In fact, the primary reason that investors struggle to find success with their investments is investor behavior. We allow emotion to drive our investment decisions; and instead of investing according to an investment policy or within the context of a financial plan, we invest in reactionary mode—continuously moving and changing according to the headlines.
If you were to scan the financial media sites (as many people do), you’ll likely see numerous conflicting headlines. One story will discuss how the market collapse is all but imminent, while another analyst is predicting a continued bull run. All of this instant, yet conflicting, information is designed to do 2 things: 1) keep you coming back for more updates and 2) selling advertising space on those sites or articles. It may sound trite, but it’s the truth.
One way that we can verify bad investor behavior at work is to look at the inflows and outflows of money in market investments. For instance, the recent market correction happened at a frenzied pace. Over just 7 trading days the market shed about 11%—a pace that would catch anyone’s attention. However, one of those days (August 25th), saw net redemptions of mutual funds of $19 billion—the second largest single day outflow since 2007. Despite the countless studies that reference market timing as a no-win strategy, folks still try to be the first off the bus when the road gets bumpy.
Here’s a great video that shows how investors tend to pour money into the markets at precisely the wrong time, get burned, and repeat the cycle over again.
Investing is hard. Not because of the lack of information—but because it requires discipline and emotional fitness. The BEST way I know how to help investors during rough times is to remind them to focus on what we can control—our plan, our spending, our process. Then, we trust the process. We don’t rush the process—we TRUST the process.