Investing can be counter-intuitive, which is why it is difficult to make the right choices at the right time. In periods of market volatility it is important not to let emotion drive investment decisions. As illustrated below, positive market performance creates an air of optimism, excitement and eventually euphoria. However, these prolonged periods of positive market performance represent an increased level of risk as portfolios may have reached a high point. Markets are cyclical by nature and do not always go up. When they begin to decline, euphoria can turn to anxiety, desperation and eventually to panic. It is during market declines that the greatest buying opportunities present themselves, though it hardly feels that way at the time.
Investor Emotional Response Illustration
Stock Fund Flow Data (1/1/99 – 12/31/10)
This chart illustrates how euphoria and panic can push the flow of money into and out of investments. In 2000 when the tech bubble burst and the market declined, inflows to stock funds peaked based upon investor optimism from past years of positive market performance. In 2008 during the financial crisis and subsequent market collapse, fearful investors pulled out of stock funds thereby missing the market recovery in 2009.
Investor Behavior Penalty
Making investment decisions based upon emotion usually hurts portfolio returns. This is referred to as the Investor Behavior penalty. It is evidenced by the fact that the average stock fund return for the 20 years from 1990 to 2010 was 9.14%, but the average stock fund investor only experienced a 3.27% return for the same time frame. It is our job to help clients feel secure in both up and down markets so that they can avoid negative behavior that could jeopardize their financial future.