We know from the field of behavioural finance that people tend to feel the pain of losses much more deeply than the joy of gains. That’s why a bear market like the one we’ve experienced this year can be so hard to take.
When the markets become turbulent, most investors know they should keep a tight rein on their emotions. But in the heat of the action, when markets are sinking, it’s not easy.
There’s just so much uncertainty. You don’t know how bad the bear market will get or how long it will last. And don’t look to the media for help. Stock market commentators tend to focus on the negative and trot out clichés like “It’s a stock-pickers market” or “Buy and hold is dead.”
These bromides encourage people to trade their investments, but if you’re tempted to veer away from your long-term financial plan, ask yourself one simple question: Then what?
Once you make the decision to sell stocks to avoid further losses, what comes next? At some point, you will have to buy back into the market. But how will you know when it’s safe? In the meantime, you risk missing out on returns when the markets rebound.
Or you might be persuaded to purchase an actively managed mutual fund based on its past performance. However, we know that only 18% of actively managed Canadian equity funds outperformed their benchmark over the 10 years to December 2021, according to the S&P SPIVA Canada Scorecard. Actively managed U.S. and international funds have similarly dismal track records.
If the mutual fund you’ve chosen underperforms, then what? Do you go in search of yet another fund in hopes it will do better? Or perhaps you try your hand at picking individual stocks even though we know investors tend to fare even worse when they try this DIY approach.
In an insightful column, David Booth, Executive Chairman of Dimensional Fund Advisors, acknowledges that the uncertainty of the markets and life is highly challenging for people. However, he also observes that with uncertainty comes opportunity.
“Most of what happens in our lives is unpredictable, and it’s impossible to forecast the future,” Booth writes. “But you can live your life fully without knowing what’s going to happen. And you can have a good investment experience without forecasting what the market is going to do, because you’re not trying to guess which companies will succeed and when. You’re investing in the ingenuity of people to solve problems and make their companies run better.”
While the future course of the markets is impossible to predict, we can control how much risk we take; how broadly we diversify our investments; and who we turn to for financial advice.
When our emotions start to boil, we can remind ourselves that the key to investing success is to remain in markets long enough for compounding to work its magic. Blogger Ben Carlson put it this way: “The bedrock of my investment philosophy is based on the idea that it’s best to think and act for the long-term. But you have to survive the short-term to get to the long-term.”
Your goal should be to make decisions based on a well-structured financial plan and a tried-and-tested evidence-based approach to investing.
Then what? Then, you face the future with courage and optimism and let time do its work.
For more insights on how to navigate the markets, please download our eBook the Seven Deadly Sins of Investing. And if you’re not already a listener of our monthly Capital Topics podcast, I encourage you to download the latest episode and subscribe to receive future episodes.