The Cost of Emotions | AWM Insights #120
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Episode Summary
Recessions, high inflation, or all-time market highs are usually the only times investment news makes its way into mainstream media. Financial news is really incentivized to instill fear or greed and is only entertainment at the end of the day. Ignoring this noise is paramount to a better investing experience and zooming out to the big picture can help keep market adversity in proper perspective.
Emotions, or the behavioral side of investing, costs the average investor over 3% a year when it comes to growing wealth. No one can completely ignore the pain of losing money or the animal spirits when the markets are doing well. Staying objective, sticking to your plan, and avoiding emotional mistakes are must-haves if you want to grow wealth efficiently. A good advisor prepares you before market adversity hits and then communicates in a way you can understand through markets like we have now.
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Episode Highlights
(0:47) How should you deal with the market gimmicks of the media and the news cycle?
(1:15) What are the human elements of investing and our portfolios?
(1:35) The technical side of investing is what most people think is the most important part of investing. The emotional, pyschological, or behavioral side is arguagly more important.
(2:10) Withstanding the behavioral challenges of investing over your lifetime will determine whether you have a good or bad investing experience.
(2:39) The emotional side of investing must be taken into account, not just the financial science and math.
(3:00) “Be fearful when others are greedy and greedy when others are fearful.” This famous quote by Warren Buffett is his advice on the emotions of investing.
(3:26) It’s very easy to put money into investments when things are going really well.
(3:50) Nobody likes losing money and panic costs many investors dearly. An advisor that is objective and nudges you to invest for your long-term goals even during stressful markets and coaches you to stick to your plan adds tremendous value and a better investing experience.
(4:15) The financial media industry is built to encourage trading, overly focus on the short term, and certainly have no incentive to help you to achieve your individual priorities.
(5:35) It is normal to have the psychological response to down markets. It is also the job of the advisor to look for risks in very good up markets.
(6:09) Objective advice and answering questions with the data and the science and according to your long-term goals is what affords a better investing experience where you only focus on the big picture.
(7:10) The news outlet are encouraging you to do something and most of the time that is not in your best interest.
(7:30) Ask the question of the motives behind TV, social media, or newspapers that want to scare you and then offer their answer of what you should do. It is usually transactional with a benefit to themselves.
(7:45) Confirmation bias and where you get your news from is important to always be aware of. Ask yourself, what if I’m wrong on this take? What does the data and facts dictate. Trying to remain impartial is a skill in itself.
(9:00) What happens when the Federal Reserve raises rates?
(9:10) How long will inflation stay high?
(9:30) We don’t make decisions based on predicting the near term future. This would be emotional decisions and not aligned with your long term plan.
(9:55) Your plan and portfolio should already be ready for events like we have today. You should be ready and prepared for adversity.
(10:50) Decisions should be made to achieve priorities and goals in life. Updates to the plan are constant and ongoing but shouldn’t be made emotionally. Thoughtful advice that maximizes your chances of long-term success will always improve your odds to live the life you want to live.
(12:00) Average equity investors underperform by -3% over 30 years. This is the cost of the emotions and the behavioral component of investing. This is panicking and selling when you shouldn’t and includes the expenses of trading. It doesn’t even account for the tax bills when you liquidate a portfolio.
(13:03) The cost of underperforming over 30 years when you start with $100,000 is a difference of $1.2 million. You could end up with $2 million if you stay the course and stick to the plan. But the average investor couldn’t do that in the study so ended up with $789,000.
(14:00) This doesn’t mean you should stick your head in the sand but take information in context. Rely on the priorities that drive your plan and be aware of people encouraging you to be constantly buying and selling.
(14:50) March of 2020 was a perfect microcosm of staying the course and tuning out the noise. So many people panicked and were selling fear in the media. The people that stuck to their plan and listened to the objective advice were rewarded.
(15:40) It doesn’t mean you shouldn’t ask questions but focusing on the what has worked in the past and not making emotional decisions has led to amazing results.
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+ Read the Transcript
Brandon Averill (00:18): All right. Well, we're back, Justin. We obviously hit on some smart diversification last week, gotten into the technical side a little bit more calculated. But we're going to move to another kind of wrapping up our series here. But move to the touchy-feely side a little bit, really dealing with the emotions of investing, the marketing gimmicks that we get thrown at us, a.k.a. the news cycle. But really how to deal with these things and really how to make them a big part or a good part of your investment experience, as opposed to being inundated with things that make you make bad decisions ultimately into the end of the day.
Brandon Averill (01:01): So we'd love to just kind of jump in there, Justin, maybe start to give us a little context here as we move away from, like I said, the technical side, kind of the nuts and bolts. And we have to start dealing now with the human side of our portfolios. What are some of the things that we can consider? How do we deal with these things, et cetera, kind of broad question?
Justin Dyer (01:21): Well, we're moving away from the technical side, which I think a lot of people almost can say is the most important side. However, I would flip that comment really on its head and say the behavioral side, the psychological side, the emotional side is arguably more important. Certainly just as important as understanding just the financial science or the economics or whatever term you want to throw at this overall investing conversation.
Justin Dyer (01:52): The psychological side really is incredibly important. And I was actually just ... We do a little prep before we have this, and I saw a quote that said, "Essentially, a good investment experience or a good financial plan is only as good as your ability to withstand the behavioral challenges that you will most certainly encounter over your overall investing journey."
Justin Dyer (02:19): So, yeah, this is a little bit more of the touchy-feely side, but taking a step back and understanding what we're talking about here can be incredibly powerful and really be the difference between a good investing experience and a bad investing experience. Obviously, this whole series has kind of been an amalgamation of various items that lead to an overall positive investment experience.
Justin Dyer (02:42): But these last ones here that we're really kind of coming down the home stretch with are really, really, really important at the end of the day.
Brandon Averill (02:49): Yeah. And I think just to highlight even on that emotional side, this is all natural, right? It's natural for these things to pique our interest. It's why the famous Warren Buffet quotes out there, "Be fearful when others are greedy and greedy when others are fearful," because it's counter to what you actually should or what you're probably actually internalizing and feeling. You want to actually be on the other side of that.
Brandon Averill (03:13): And I think you can certainly go too far if you're just being contrarian just to be contrarian, that's a problem as well. But you start to think about this kind of ebb and flow of emotions when markets are super high. A lot of times we'll talk with clients and they're really excited. They want to invest more. It's really easy to put money into investments when things are doing really well.
Brandon Averill (03:35): But then on the flip side, when market's correct, certainly without removing the emotion, that becomes oftentimes some of the most difficult times to be invested and to stay invested and really having ... It shows the true value of, or one of the big values of having advisors is we're trained in removing that emotion, looking at things a little bit more objectively and helping clients to get to a better investment experience.
Brandon Averill (04:01): But it's natural to go through these swings, but it is taking a step back and then putting it all into perspective. And unfortunately, what we have is a multi-billion dollar, probably trillion dollar industry that really wants to prey on us to kind of go in and out. If you start to think about all the trading commercials and all that type of stuff. You've got Jim Cramer, "Buy, buy, buy. Sell, sell, sell, sell." It's tough, right?
Brandon Averill (04:28): Those things inundate us. We all know it. We're all susceptible to it. And you have to kind of look the other way and really simplify things.
Justin Dyer (04:36): And I think it's a great place to maybe dig in a little bit further. Ask yourself where the advice is coming from. What is their interest in providing this "advice"? What's their economic model? Jim Cramer is not truly trying to sell advice. I used that term, but Cramer, CNBC, Bloomberg, et cetera, et cetera. They're not really selling advice. They are selling ads and you are the customer essentially, or you are the product rather, excuse me.
Justin Dyer (05:09): And the more that they can keep you glued to that TV, computer screen, phone, et cetera, et cetera, the more profitable their business is. The higher revenue there is. The more they can charge their advertisers, et cetera, et cetera, down that road.
Justin Dyer (05:24): And understanding those incentives is a real important place to start. But then also realize, and Brandon, you've already hit on this, but just the general psychological nature of this, it is totally normal to ask these questions, to react in an emotional way really at the end of the day, when markets are going up and down.
Justin Dyer (05:49): It's an incredibly valuable role that an advisor plays to be that intermediary, if you will. There's many other valuable roles that advisors play within a relationship, but being able to take a step back, "Hey, let's pause. Let's look at what the data says," which we talk about ad nauseam here.
Justin Dyer (06:08): But let's look at the data. The data, there is so much information out there which can be part of the problem, if you will, going back to these news outlets and whatnot. But it's also pretty easy to get really good data and really good answers to your questions.
Justin Dyer (06:27): Now, it doesn't always calm you emotionally and really settle things down necessarily right out of the gate. But it's really important to go through this whole process, understand where information is coming from. What are they actually trying to do? Is it sound advice? Are they bringing more of a transactional relationship to you? So much of the world we live in today is transactional in nature.
Justin Dyer (06:57): And very, very, very infrequently is buying and selling something actually, what should be done. And so just all of these little tidbits, what are their incentives? What kind of model or what kind of business model is the outlet that you're consuming news from? What are they running? How are they trying to get underneath your skin so as to keep you engaged, keep you scrolling, et cetera, et cetera? Justin Dyer (07:24): Asking all these questions are really, really important to help you process all the information that comes at us on a day-to-day basis. And then, ideally, talk with your advisor and think through this more from a longterm perspective and go back to your plan.
Brandon Averill (07:39): And just also, I think the context of where you're getting this information from is a lot of times good. We're all confirmation biased. If I really like the Los Angeles Rams, I'll probably read the Rams fan boards. And I don't know who the rival is. I'm exposing myself, but on the other side of the float board, there's probably somebody with a different take, for instance.
Brandon Averill (08:04): And it's no different than in the financial markets. I think going back to the incentives, a lot of these news outlets are trying to create kind of, they want you to tune back in tomorrow. And so what does that need you to do? There needs to be there some anxiety or optimism or something to get you to come back.
Brandon Averill (08:22): They're not just going to say, "Hey, look, we may be going through a recession. It doesn't really matter when it comes to your market portfolios, take a long term approach." That's not going to get you to tune back in tomorrow. They want the dopamine hits. They want you to check the app again and again and again.
Brandon Averill (08:38): And when you start to think about this, I was talking with a client the other day, and they're like, "Well, inflation's definitely going to run away." So, okay. Well, definitely? How do you know that? Interest rates are definitely going up. Look what the Feds are doing. They're raising rates, like all interest rates are going up. Well, how do you actually know that?
Brandon Averill (08:55): If you look what happened when they just raised rates, the market anticipated that what may happen in rate rising, but for the week after they raised the rates, rates actually went down on a lot of the spectrum. Inflation, everybody is screaming inflation could be high. It may stay high for a long period of time.
Brandon Averill (09:13): But in reality, the Fed is probably going to make some of these adjustments. Inflation is probably actually going to come down over some period of time here. We're not going to run at 9% inflation for the rest of our lives.
Justin Dyer (09:24): And those are all totally valid points. And I think it's important to underscore, we're not saying we know what will actually happen here. We can chime in and say, "Hey, inflation likely will come down." But at the end of the day, we don't know. And we're not going to make a decision based on that projection.
Justin Dyer (09:42): I mean, that is what the data says time and time again. Don't make these knee-jerk reactions based on what's happening right now. You should have a portfolio and a plan in place that, A, you understand, but B is built to deal with environments like this before they happen. Making a change now, it's okay to ask. It's good to ask and reassess, but making a change in the midst of it is not. It has never really been a tried and true method to success at the end of the day.
Brandon Averill (10:15): No, I think at the end of the day, if you're trading on or you're making decisions based on emotions, that's always a very difficult place. I mean, any aspect in life. You get in a fight with your spouse. You probably want to take a breather-
Justin Dyer (10:27): Sleep on it.
Brandon Averill (10:27): ... before you go through it. You're making a big job change. You're signing a contract, a multi-year contract. You're probably not just grabbing the pen and scribbling, unless somebody is really overvaluing you. However, you give it some thought. You talk with your family, et cetera.
Brandon Averill (10:44): You don't make these quick decisions and you allow your priorities, your goals at the end of the day, to dictate how you make decisions. And it should be really no different with your investment portfolio. You should be in a portfolio that you can be very comfortable with and understand. And that goes back to financial structure.
Justin Dyer (11:03): And we talk a lot about, "Okay, go back to the data. There is a lot out there and the source of that data or that information is critical." We've hit on that. But what does some of this data actually say? Here's some real basic numbers around ... This is some data around investor behavior, sticking the course or sticking to the course, being a longterm-oriented individual.
Justin Dyer (11:26): There's a company called DALBAR in our industry. They put together an average investor return study. Basically, what they do is they'll survey a number of "average investors" assess what their overall performance is. And then just compare that to the S&P 500. You could look this up D-A-L-B-A-R study, and you'll find all sorts of information on it.
Justin Dyer (11:47): And the numbers over a 30-year period through the end of last year, so December 2021, basically, for the average equity investor, you could look at this a number of different ways. But the general trend is the exact same. The S&P 500 returned 10.65% over that 30-year period of time ending last year. The average equity investor, and I'm not going to go into the exact definition, but it's a robust way in which they're defining the average equity investor, underperformed by over three percentage points.
Justin Dyer (12:20): They returned 7.13% rate of return. That's due to a combination of behavioral, emotional considerations. Selling when you shouldn't sell, buying when you shouldn't buy, et cetera, et cetera, just having this knee-jerk reaction because it happens throughout history, throughout market cycles and also fees. Fees are a big component of that. Taxes aren't even included in this. This is just the numbers that are reported.
Justin Dyer (12:46): So these are all things we've talked about through this series. We're talking about and kind of summarizing here as we come to the close, but that's a meaningful difference. If you just did a simple compound number, we're going to get back in the technical space here. But if you just did a compound calculation of 10.65%, what the S&P 500 did, and let's call it 10% over a 30-year period of time, that's a substantially different amount of wealth.
Justin Dyer (13:14): Looking at this amount, if you invested, let's see I'm doing the quick math here, a $100,000 beginning of that 30-year period, it would turn into over $2 million, just holding the S&P 500, earning three percentage points plus less as the average investor did in this study, $789,000. It's $1.2 million, over 50% less total wealth at the end of the day because of the incredible power of compounding interest really, or compounding growth at the end of the day.
Brandon Averill (13:48): And just to be clear, what we're not saying is stick your head in the sand and don't pay attention to anything. But what we are saying is take information in context. And then rely upon the priorities that you put into place, have confidence in the financial structure that you've built with your advisors, and then allow your wealth to grow in a very sustainable, very smart way rather than falling prey to the Wall Street animal, to the business model of the broker dealer, the Merrill Lynches, Morgan Stanleys, Goldmans, the traders, all those people out there.
Brandon Averill (14:23): Just stay away from that, stay off CNBC. Fill your time with other good stuff. You don't need any of that in your life.
Justin Dyer (14:31): And just to chime in kind of last statement here too, we have some really good recent experience. So some of our clients, some of you listening are newer to the investing game, or not game, the investing world. But it's not too long ago, March of 2020, or all of 2020 was an interesting period of time. That was when the pandemic started. That's not too distant.
Justin Dyer (14:55): And that was a perfect little microcosm of exactly what we're talking about. Not every single correction or market environment is the same, but there's a lot of lessons that you can learn throughout history really. There is one in 2008, 2009, the great financial crisis. And sticking the course and being disciplined and tuning out the noise and asking the questions, but not reacting based on emotion.
Justin Dyer (15:21): Just again, over these more recent periods of time has proven to be the correct way of doing it. And it's also proven itself in years past. So it's not like this is a, "Hey, this time it's different," type mentality to have. It really isn't, but it's good ... Again, it's healthy to ask those questions and then go through this whole process that we've really highlighted today.
Brandon Averill (15:44): For sure. So we're going to wrap up. Hopefully, this is a little bit of help just how to frame some conversations. We're going to tie a bow on this entire series in the next episode. We're going to really dig into focusing on what you actually can control. We'll do a little bit of a recap, but hopefully like I said, put a bow on this entire series. And hopefully, it's been valuable.
Brandon Averill (16:05): As you know, if you've been listening at all, you can join the AWM Insights community by shooting us a text. Text comes right to my phone. It's 602-704-5574. We'd love to hear from you. We'd love to be able to push this stuff out to you and get back to you on questions in the future.
Brandon Averill (16:21): And until next time, own your wealth, make an impact and always be a pro.