September 21, 2021

A look inward: Are your own instincts sabotaging your investing?

The following article was written by Leith Wheeler VP & Portfolio Manager Leanne Scott and first published in CanadianFamilyOffices.com. It has been reprinted here with permission. You can read the original article and other thought leadership focused on family offices here.

How emotional responses can result in a self-destructive exercise in bad market timing

Author: Leanne Scott, CFA

Investing can be an emotional roller coaster. Ask anyone who peeked at their portfolio balance in March 2020, or April 2009, or the better part of the first two years of this century.

When investing, and no matter your net worth, you’re going to have emotional responses. But they don’t need to (and shouldn’t) dictate the decisions you make along the way. Emotional investing is what happens when you succumb to your impulses and overreact to market gyrations, rather than to an analysis of the fundamentals.

Investing that is driven by emotion – greed or fear, for instance – often becomes a self-destructive exercise in bad market timing: buying at market highs and selling at market lows.

So, how can we avoid emotional investing and keep ourselves on track?

First, let’s look at some drivers of emotional investing. By recognizing our innate biases (we all have them), we can find ways to manage them.

Hindsight bias: We often believe that after an event has occurred, we would have predicted or even known the outcome of the event before it occurred. Also aptly named the “knew it all along” phenomenon, that’s hindsight bias in a nutshell: the tendency to view past events as more predictable than they actually were and then erroneously believe we could have had more control over them than was reality.

Fading affect and egocentric bias: We’ve all been at a cocktail party and heard friends or family talk about how much money they made on an investment. Funny how we never hear about any of their losses… These two concepts related to hindsight bias describe this “selective memory” tendency to forget our mistakes and overemphasize our wins.

Greater fool theory: Those under the spell of this bias have a perceived ability to buy and sell a stock quickly enough to profit off a “greater fool” – aka the next person rushing in. Fundamentals are thrown out the window as this becomes a game of pure momentum, with someone ultimately left holding the bag when prices come back to earth.

Letting these biases overtake your investment strategy often leads to underperformance – and the current environment is particularly fraught. With trillions of dollars being pumped into financial systems around the world, low returns available in bond markets, and a sense of hubris from the astronomical stock market gains coming out of the short-lived COVID-19 crash, investor appetite for risk-taking is high and speculative pockets are emerging. A few examples are cryptocurrencies (Bitcoin, Ethereum, Dogecoin), Robinhood/meme stocks and special purpose acquisition companies (SPACs).

What is an investor to do?

Now let’s take a look at what you can do to ensure these biases don’t negatively affect your investment returns...