Emotions and Investing Decisions

My camping trip changed from a getting a basic tent to renting an RV for our weekend getaway in the local mountains.  After a few days you start to find peace in nature – no cell phones for the adults and playing in rivers with dirt and rocks for the children. I think we have caught the RV bug and we are hoping to take another trip in the next couple of months.  Just like my progression from basic camping to the complexities of using an RV, the Fed has also been moving from risk free bonds to buying junk corporate bonds via special purchase vehicles.

This is beyond normal operations and is into the shoring up of the overnight repo market, commercial paper, bank’s short-term lending and now public companies. All of these functions are not typical when in a healthy economy. At first, when buying corporate bonds, the Fed used bond ETFs to be non-biased. 

Now, the Fed is purchasing individual bonds directly.  Keep in mind, this is taxpayer dollars buying bonds of companies with the highest risk of default. Obviously, the Fed should not be holding these types of assets.  We have covered the long-term impacts in a previous post but a CliffsNotes version is that by removing the ability to price securities based off their creditworthiness every company is getting a participation trophy.  Like my daughter getting a participation trophy; it’s great for kindergarteners, but not so much for investors. 

Emotions vs. an Investing Process

This March, when stocks were going down the most, many investors thought about selling out of their investments because of fears that the stock market would drop further.  Some wealth management firms sold their client’s equity positions in the first week of March, stating that there were too many uncertainties to feel comfortable.  This week, since stocks have rallied, some investors are wondering if they should sell out of stocks because asset prices have risen way too fast without supporting economic data.

The truth is that no one knows what is going to happen with investments and that is why we follow a defined process.  The only time we make trades is if we hit certain thresholds within the market that cause us to rebalance or if the economic data changes resulting in an adjustment of our tactical positions. Theoretically, it is really that simple, but it is extremely hard to do on an ongoing basis.  This highlights that the fundamental difference between an investor and an investment is emotion; as uncertainty grows so does emotion.  According to the Dunbar Investor Study people who manage their own investments of $1 million or more averaged a little over 3% return over the last 10 years (2009-2019), while investments in a diversified portfolio of 50% stocks and 50% bonds returned 6.8% over the same time. That’s over a 40% difference over the same time frame.  It makes sense to me, since people who sold out in 2008 didn’t start getting back into the market until the end of 2010.  It will be interesting to see what the 2021 study shows, because in periods of volatility having a well-defined investment process is the only way to stay disciplined.  

In the chart above you can see about 1/3 of all investors age 65 and above have removed their equity positions. This is 100% because of emotions.  Again, as uncertainty grows so do our emotions when making decisions.  And with the benefit of hindsight, it is clear to see that we have gone from oversold to overbought when put/call ratios have inverted.  One of my goals in these blog posts is to over- communicate our process and reinforce our evidenced backed process to deter any emotion-based decision making.  Some of the topics are repetitive, but with COVID19 most of us are watching the news and are viewing our accounts on a daily basis.  This is when you need conviction in our process and investment discipline the most.

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