By: Ryan P. Johnson, CFA, CFP® - Director of Portfolio Management & Research
Since our last Market Insights update, the S&P 500 made several new highs and even made it to thirteen straight weeks with a new high. The Nasdaq crossed 15,000 for the first time and the largest companies have recently outperformed the S&P 500, including Microsoft, Alphabet (aka Google), Amazon, and Facebook. Still, over the past month, stock indices, bond yields, and even commodity prices have been fairly unchanged. Unemployment continues to improve, and the Federal Reserve continues to discuss reducing bond purchases, or tapering, which is expected to start later this year. Inflation continues to be a concern, with the latest read on core consumer prices being 4.0% higher than a year ago, though this was slightly better than the previous month’s reading of 4.3%.
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Speaking of our minds, but also our hearts, it is important to remember that fear should not drive your investment decisions. While volatility has remained low recently, a 5-10% sell-off in stocks is historically common and fear can occur whether markets are up or down. The fear of missing out (FOMO) is worrying about not participating in a hot investment trend, while the fear of losing it all (FOLIA) is worrying about investments declining or even going to zero. Recognizing when you are being especially fearful (or greedy) is helpful as an investor, and it is often better to do the opposite of how you feel. Emotional investing can unintentionally lead to market timing at just the wrong time. Recent cases of FOMO may have centered around Special Purpose Acquisition Companies (SPACs) or cryptocurrencies. FOLIA last appeared in March of 2020, but the S&P 500 has more than doubled since then. Stocks or other investments often start to level off once good news starts to decelerate. Likewise, when bad news does not become worse, prices often start to rebound.
Why do emotions affect our investment decisions? As humans, we tend to avoid pain or seek pleasure. Losses seem to hurt more than the pleasure derived from gains of the same amount. These feelings, or emotional biases, can lead to investing too conservatively (trying to avoid any losses) or not making changes out of fear that the decision will turn out poorly. As the band Rush once sang, “If you choose not to decide, you still have made a choice.” Seeking pleasure could even manifest in not saving enough today for longer-term goals such as retirement. One other example of an emotional bias is called the endowment bias, which is valuing what you own more highly than other investment opportunities.
How can you overcome emotional biases? It is best to have a plan before you take action. It can also be helpful to invert your thesis by asking yourself what you would do if the opposite of what is expected occurs. Another useful tactic is asking yourself what you would do with your investments if you had only cash and had to start from scratch today. Focusing on fundamental analysis and trying to put the decisions at hand into cold hard numbers can help make decisions more cognitive and less emotional. It can be difficult to correct emotional biases, so it may only be possible to recognize, then adapt or adjust, rather than being able to eliminate emotional biases completely.
Working with a trusted financial advisor can help you see extremes in a historical context and work through times when emotions tend to take over. Starting with a financial plan that fully integrates investments and taxes can help you grow, protect, and save your assets. Sticking with the plan in tough times and overcoming emotions is paramount to long-term success.
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Ryan P. Johnson, CFA, CFP®
Director of Portfolio Management & Research
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.