Published January 3, 2020
One of the benefits of a subscription to TimingCube is the cache of weekly articles on investing, investor behavior, and economics. While most of these articles are archived in our Blog, there are a good number of classic articles held in our Knowledge Base (see the menu at the top and choose Resources to find both the Blog and the Knowledge Base). One of those classic articles is reprinted below discussing Emotions and Investing. You will quickly note that this article was written shortly after the financial crisis when it was far from clear that the ensuing decade would produce the gains that it has. While the past decade has been relatively benign, we know from market history that calm precedes turmoil and vice versa. Nonetheless, the discussion items in the article hold true for all investors we feel.
Emotions and investing – a primer on TimingCube
As most investment newsletters we do spend a lot of time on the markets and what affects them, on technical indicators and investment vehicles. Another topic we visit fairly frequently in this column is the emotional side of investing which we judge to be just as critical for success. A long-term wealth building program must by definition be emotionally sustainable.
With all the tumult going on these days, it is no surprise to see high levels of unease, uncertainty and doubt. The fear of losses or, when the next signal comes, the fear of being on the wrong side of the market are tell-tale signs of investors at risk of letting their emotions disrupt their strategy. Most investors have trouble balancing greed and fear. We like to frequently remind ourselves that emotions are our worst enemy.
A landmark 1994 study by Morningstar demonstrated that individual investors lose money on even the best mutual funds. It showed that while the average growth stock fund gained 12.5% per year over the study’s 5 year period, the average investor in those same funds lost 2.2% per year. Why such a huge difference? Because of human psychology and the fact that people are highly emotional creatures, most investors cannot bring themselves to simply buy low and sell high. A 2007 study on the “Impact of Emotions on Retirement Investors” confirmed earlier findings once more by observing that although three of four investors (76%) are negatively affected by their emotions, only one third (35%) believe emotions impact their investment decisions. This is a warning sign: most of us are negatively impacted yet we don’t believe we are.
Yes, there are many factors affecting and influencing our emotions:
• Our character/predisposition
• Our risk tolerance
• Our expectations
• Our investment time horizon
Emotions can take many forms and result in unpredictable investor behavior. Some of us are so overwhelmed and scared by the extent of the economic turmoil and its effects on the stock market that we simply freeze and go into hibernation waiting for better days. This presents the distinct risk of leaving us stranded in our den long after a new signal has been issued and missing the corresponding profit opportunities. Others are more the impatient type and their emotions drive them to jump into action in order to make up for losses or lost time.
We also want to take this opportunity to welcome our most recent subscribers and recognize them for their distinct set of experiences and emotional baggage. Contrary to our longer-term subscribers who were largely unscathed by the 2008 bear market, many of the more recent arrivals suffered severe capital losses during that time, and their perspective can be quite different. The emotional toll could not be worse than that inflicted on a buy and hold investor during a bear market. Except maybe for a highly leveraged buy and hold investor. On the bright side, by learning the buy and hold lesson the hard way you now truly understand why it makes perfect sense to time the market: to avoid losing your shirt during bear markets! Yet, because of the old adage “once burned, twice shy” these subscribers are amongst the most likely candidates for sudden paralysis in the event of a signal.
So, now that we know what emotions can do to us we can look at what we can do to keep these emotions in check. Here are a few simple steps to manage your investor emotions.
1. Have a plan
We often describe the objective of Trend Timing as participating in all significant market moves and avoiding all significant declines. We firmly believe in the merits of a mechanical system in large part for removing emotions from the investment process. Our approach is 100% mechanical, rigorously unemotional, and leaves no room for analysis or interpretation of data or news events. The system is not perfect and not all signals will be winners. It does not have to be perfect because over time the absolute protection it offers against significant losses will always keep us safe and beat the market.
Rather than perceived risky tactics, market timing signals are the key ingredients in reducing real market risk, helping us keep our emotions in check, and allowing us to stick with our wealth building model for the long run. But since you are reading this, you obviously have taken the first step in having a plan.
2. Turn off the noise and the distractions
Maybe most importantly, Trend Timing gives us the luxury of not suffering through the minute by minute, hour by hour agony of market days like we have experienced recently. Too many investors spend too much time glued to the financial news networks and data feeds. News, forecasts, guesses or other subjective judgments, opinions and rationalizations, however educated and inspired they may be, play no part in determining the market trend. You don’t need them. Your health is negatively affected by them. And most importantly, your investment results are not improved by them. By trusting our mechanical trend following system you can achieve superior long-term results without worrying about what the market should be doing or why it is doing what it does. With practice you can achieve results and peace of mind.
3. Be prepared
Last but not least, you need to pre-condition yourself to pull the trigger unconditionally when required. In order to prepare ourselves mentally to execute the plan when the time comes, we want to walk through, and write down, all the steps and rehearse exactly what we will do with a Buy signal and with a Sell signal.
- Make sure in advance that you will receive, and recognize, our signal change e-mail. Use the “Test E-mail Addresses” function at the top of the “My Profile” page to verify end-to-end delivery
- Write down your broker(s) account(s) details including Web site addresses, account numbers, user IDs and passwords (also capture the broker phone numbers, just in case their Web site is down or you run into problems)
- Select your strategies
- Select your investment vehicles
- Make the commitment to execute promptly.
Always remember that it is by participating in all the major moves and avoiding all significant downturns that Trend Timers build their wealth, and keep their sanity.
This week saw markets close the books on a strong 2019 performance while opening 2020 with a bumpy ride. Monday’s rebalancing of year-end portfolios, where profits and losses are often taken for tax purposes, left stocks lower by -0.6%. Tuesday’s quiet New Year’s Eve session closed slightly positive. Stocks kicked off 2020 with a big move higher as economic stimulus from China provided a spark for international and economically cyclical stocks. The S&P 500 raced ahead by +0.8% while the more tech-focused Nasdaq rose +1.3%. Most of those gains were handed back Friday after the overnight news of a U.S. airstrike targeting an Iranian military leader. Stocks opened down and held those losses throughout the day en route to a -0.7% slide. The increase in Middle East tensions sent oil prices higher by almost +4%.
Stocks finished the back and forth holiday-shortened week little changed. The S&P 500 (SPY) ended -0.14% while the Nasdaq 100 (QQQ) closed +0.27%. The small-cap Russell 2000 (IWM) dipped -0.44%.
Warm wishes and until next week.