The Crucial Role Of Emotion In Investing

Just a quick post for today.

A few days ago, I wrote an article for this blog entitled Millennials: Here's Your Best 2016 Investment Portfolio. Long story short, my friends over at Seeking Alpha apparently liked the article enough that they reproduced it on their site.

I received several comments on the article; some extremely favorable and even a little emotional for me. Others, not so much. Here's an example:

You say this "plan" is for people in their mid 20's early 30's.

Bull.

Anyone that age should have a high appetite for risk, and therefore growth, which is only achieved by picking individual stocks.

Keep your paltry gains. Anyways, that's investing on easy mode. No fun, and meager returns. I wish you would have included this in your article.

Well, at least the commenter had an unequivocal opinion. I like that.

However, one very obvious dilemma springs to mind. If it was an easy thing to just get up in the morning and consistently beat the market, then everyone would be doing it. In fact, one of the factors that got me into index ETF investing in the first place was Vanguard's research demonstrating that only a small percentage of professional managers have been able to consistently beat the market. So, easier said than done.

But let's just briefly talk about one other critical factor when investing.

Emotion.

Put simply, perhaps the one thing that derails an otherwise solid investment plan more than anything else is emotion. Emotion is what comes into play in the middle of a serious downturn. When the market has already dropped 20% and is still falling. When every news story you see, hear, or read in the business media outlets seems to feature yet one more piece of bad news. And when your portfolio balance is falling just as badly as the market, likely even worse since you have been focusing on aggressive gains. You feel like the "sky is falling." Everything you have worked so hard for is evaporating, right in front of your eyes.

And so you panic. And you sell. And the market falls another two percent. And you feel good because at least now you are out. There's no more pain. Like taking an investment Advil. And then, the market turns upward. But you don't believe it. That huge loss freaked you out. You are afraid of a repeat. And the market rises, so quickly in fact that it catches you off guard and completely paralyzes you. Before you know it, it is up a full 10%, or 8% higher than when you sold everything. And you're still sitting on the sidelines.

In contrast, the individual with a diversified portfolio watched the value of their holdings drop as well. But, because certain asset classes softened those losses, perhaps they found themselves only down 10-12%. Instead of panicking, they rebalanced their portfolio, moving a defined amount of funds from the asset classes that outperformed into those that were now the cheapest. And, when the market rose 10%, their portfolio came back relatively strongly as a result.

But, perhaps more importantly, they slept well at night. Their stress level was lower. And, as a result, because of the well-documented effect of stress on a person's health and well-being, they were actually healthier.

Again, to each his (or her) own. Just thought I would leave you with a perspective to consider.

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