How emotions influence investments

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EMOTIONS can be a powerful force in our lives, and investing is no exception. While a cool head is crucial for success, many investors struggle to stay composed when markets become volatile.

Fear, greed, and impatience can cloud judgments, leading to impulsive decisions that can undermine long-term financial goals.

Why is this so? To understand this, first, we need to understand the concept of the “Market Cycle of Emotions”.

The “Market Cycle of Emotions” illustrates the rollercoaster ride of emotions that investors go through in an investment cycle over time.

When markets are booming, investors tend to be thrilled, optimistic and euphoric, leading them to invest more of their money.

Conversely, when markets crash, investors become apprehensive, fearful and panicked, often cashing in their investments to avoid further losses.

Thus, instead of buying low and selling high, which is the golden rule for investing, emotions triggered by the market influence investors to buy high and sell low instead.

It is important to recognise that our emotions exist for the reason of protecting us and warning us when things do not seem right.

However, when it comes to investing, those same emotions can drive us to make instinctive decisions that feel right, but in reality, put our hard-earned money at risk.

Therefore, having means of balancing our emotions and logic is important when investing in the long run.

That’s where the role of an independent financial adviser comes in. We act as your voice of reason during these turbulent times by helping you stay on track and make sound decisions based on logic, not fear.

We can help you navigate the emotional rollercoaster by presenting the cold, hard facts about the market and reminding you of your long-term investment goals. And it’s not just my experience.

A Vanguard study titled “The Value of Advice: Assessing the Role of Emotions” in March 2020 showed that a significant part of an adviser’s value comes from managing emotions.

They found that 40% of the benefit investors receive is emotional – feelings of confidence in their portfolios and excitement about the future, even during uncertain times.

Roller-coaster investing

To illustrate this, I would like to highlight the case of one of our clients, Alex.

Alex started his investment journey with us in 2016. Back then, favourable market conditions helped his portfolio flourish, yielding impressive returns.

His moderate portfolio achieved a compounded return on investment (ROI) of 7.7%, and the more aggressive portfolio achieved a compounded return of 10.5%.

Fast forward to two years later, escalating tensions between China and the United States had triggered market uncertainty. Alex, feeling uneased, scrambled to contact us with the intentions to sell all his investments immediately to avoid further loss.

Our independent financial adviser, Jackie, reassured Alex. She urged him to take a step back from the panic and consider the opportunities a market downturn can present.

Jackie explained that buying quality investments at lower prices during market dips could be advantageous in the long run. This strategy, she said, allows investors to take advantage of the market swings and potentially see even greater returns when things turn around.

Despite Jackie’s sound advice highlighting the potential benefits of buying at a discount during the market dip, Alex remained unconvinced. The fear of an impending crash lingered in his mind. He opted to hold onto his current investments for the time being, forgoing the opportunity Jackie presented.

A year passed uneventfully. Then, out of the blue, Alex requested to switch his investments from equities to bond funds. Jackie advised against it, as it meant that Alex would be selling his investments at an all-time low when making the switch.

This contradicts the most important rule of investing: Buy low, sell high. Alex could not be talked out of his decision, and went ahead with the switch.

By mid-2019, as the market showed obvious signs of recovery, Alex was convinced that equities were back on the rise. Fuelled by the positive outlook, he wanted to switch his investments again.

However, this move could potentially disrupt his long-term investment plan. Imagine if he had sold his investments at a low point during the downturn, only to jump back into equities just before another potential dip. This frequent switching could lock in losses and hinder his ability to capture long-term market growth.

In an attempt to manage Alex’s expectations and guide him towards a more strategic approach, Jackie posed a question to him: “If in two months’ time the equity market were to go down again by 20%, would you be panicked to switch back to bond funds?”

Alex assured Jackie that he had learnt his lesson and would not let bad market conditions spook him. With Alex’s renewed commitment in mind, Jackie went ahead to put together a diversified investment plan with quality portfolios, including equities, that reflected on Alex’s goals and risk tolerance.

A year later, the World Health Organisation declared the Covid-19 pandemic, triggering panic selling, and the stock market plunged by more than 20%.

Alex, gripped by fear, sought guidance from Jackie, who advised him to top up his investments by 10% when the market dropped lower, taking advantage of the low prices. Despite Jackie’s advice, Alex remained paralysed by the fear of an even steeper crash. He opted to hold onto his existing investments, forgoing another chance to buy at a significant discount.

As time passed, the market continued its downward spiral, reaching its bottom during the height of the crisis. However, the market wouldn’t stay down forever. Eventually, it began a steady climb upwards.

In 2022, after the market recovered from the pandemic downturn, Alex’s portfolio had achieved a steady 5% annualised return. This moderate performance was commendable considering that he didn’t take any additional top up actions during the market downturn.

In contrast, clients who had followed Jackie’s advice and “topped up” their investments during the market lows were now reaping the benefits. Their portfolios saw much higher returns as the market rebounded.

Had Alex been able to manage his emotions better and strategically invested more during the downturn, he could have potentially enjoyed higher annualised returns.

Looking at Alex’s case, it’s clear that a disciplined and rational approach to investing truly pays off in the long run. When the market is doing well, you may be overly optimistic. The real test comes when the market is fluctuating and dipping, as that is when emotions like fear and panic can cloud judgment and lead to inactions or rash decisions.

This is where a third-party independent financial adviser (IFA) can be invaluable. IFAs can help investors navigate market fluctuations and make informed decisions based on their individual circumstances.

As financial experts handling a large amount of capital over multiple crisis, IFAs have witnessed numerous market fluctuations and can leverage that experience to advice clients on taking the right actions at different market cycle to grow their wealth for long-term investing.

In Alex’s case, his fears were partly fuelled by negative news presented by the private banker who was advising him on his money at the bank.

As a result, Alex made some poor knee-jerk decisions initially, such as selling off a portion of his portfolio at a low point. Fortunately, Alex didn’t completely succumb to his fears, which helped his portfolio achieve a decent 5% average performance even amidst significant market volatility.

Learning from his experience, Alex began to see the value of Jackie’s advice and became resolute to approach investing with a more strategic mindset.

Building on his newfound trust, Alex’s investment portfolio has flourished thanks to Whitman’s holistic and collaborative approach. This approach, guided by Jackie, myself, and the investment committee, entails three key steps:

> selecting high-quality investments aligned with his risk profile,

> actively managing and rebalancing the portfolio to capitalise on opportunities, and

> conducting annual reviews to restructure for even better fund options.

This strategy has demonstrably contributed to Alex’s portfolio’s strong performance since then, providing him with a sense of security.

I encourage you to relook at your investment choices during past drops. Were emotions a significant factor in your decision-making? Is there room to improve your emotional control and decision quality?

Be open to seek professional help to adopt a more disciplined and rational investment approach at different market cycles.

Equipped with better emotion management and disciplined investment approach, you can embark on the journey towards your financial freedom confidently, knowing that you will always make informed decisions that serve your best interests.

Yap Ming Hui is a licensed financial planner. The views expressed here are the writer’s own. Any reliance you place on the information shared is therefore strictly at your own risk.