Understanding your emotional reaction to investment performance can help you make rational decisions during periods of market volatility

Key takeaways

  • Our natural emotions and inherent biases towards gains and away from losses tend to drive our reactions to market volatility.
  • We can regain control over our portfolios by refocusing on our long-term financial goals.
  • Using these financial goals as a reference point, we can review our need, capacity and tolerance for risk today and for the future.
  • Make the best use of expert advice from a diverse range of sources and focus on the facts – avoid social media’s opinions on financial markets.

While speaking to our clients over the past few weeks of extreme market volatility, I’ve encountered a range of emotions. One young investor highlighted the responsibility she feels to her parents because they had given her money to invest in her first portfolio. An entrepreneur spoke about investing in the markets for the first time with the proceeds he received from the sale of a business he built over 10 years. A family business owner talked about the challenges he faces with the uncertain economic outlook, while at the same time watching his new diversification strategy of investing in the markets rise and fall dramatically.

I understand the pain. If you began investing recently, the past month has been a brutal experience. Whether you’re a new investor or more seasoned, it might be helpful to consider the following three behavioural biases that tend to peak during a crisis:

Loss aversion. We suffer loss far more severely than the pleasure we feel when we make gains. According to the MSCI World Index, stock markets across the developed world gained 25% in 2019. Most investors reacted with a feeling of satisfaction, while those with more experience began to be a little concerned about whether the good times could last. When the stock market had plummeted by 32% by 23 March due to the impact of Covid-19, many investors felt sharp pain and immediately wanted to sell to alleviate it.

Risk aversion. We just don’t like uncertainty. Most of us prefer a predictable result even if the outcome might be less financially advantageous.

Recency bias. We have a tendency to overemphasise recently received information over a longer-term analysis. For example, some of us may be comparing the coronavirus pandemic to the Global Financial Crisis of 2008, and wondering whether the impact will be more or less severe. The reality is that the two situations are very different and how Governments have responded to this crisis compared to the last will inevitably result in different outcomes.  It might also be helpful to look further back and consider how families have preserved their wealth through other challenging periods and the lessons they learned.

Understanding our biases can help us react to changing market conditions in rational ways. What can we do to think clearly and focus our perspective and actions in the maelstrom of emotions that events may provoke?

Four icons representing what you can do to think clearly and focus perspective: REFOCUS on your goals and time horizon, EVALUATE you risk approach, LOOK FORWARDS not backwards, GET EXPERT ADVICE to revisit and review your goals.

The following exercises can help to provide you with a greater sense of control.

Refocus on your goals and time horizon for achieving them

Perhaps the most critical component in every wealth strategy is clearly identifying the purpose and objectives you have for your money.

  • If you invested a few years ago, what were the goals you set? For example, to preserve your capital so that it can be a safety net for future generations of your family? To grow your capital to be able to invest in new businesses? To generate an income so that you can live your life the way you want?
  • Is your wealth strategy still meeting your goals? If yes, stay the course.
  •  If not, what can you change to get closer to your objectives?

When your goals guide your decision-making process, you have the framework to understand if you need to make any changes to your investment approach in response to evolving market conditions without those decisions being driven by emotion.

Evaluate your approach to risk today

Review three questions with your advisors by thinking about your financial goals:

  • Do you need to take some risk (say to produce an income) to achieve those goals?
  • If you need to take risk, do you have the capacity or ability to suffer investment losses?
  • Lastly, what is your tolerance for risk? If you take risk and the markets are volatile, can you tolerate it?

Look forwards, not backwards

Reviewing previous periods of turmoil – including major geopolitical events, financial crises and market crashes – can help to reassure us that conditions will return to normal at some point. However, every crisis is different so it’s important to read widely about is what is happening today and how that will drive outcomes tomorrow. Governments around the world have launched unprecedented levels of support for businesses and their workers, as well as a new wave of financial stimulus packages, and are working extensively to control Covid-19, while seeking to develop a vaccine in partnership with the private sector. How will these measures affect future market returns?

Get expert advice

Speak to your financial advisors to hear their views on the impact of current measures to mitigate the impact of Covid-19. Ask them to share high-quality information from diverse sources. Use them as a sounding board to revisit and review your goals and the actions they have taken to help meet them.

How we can help you

Your J.P. Morgan team can help you identify and review your wealth goals, and build a strategy that aims to meet those goals, which in turn can help you stay calm and control human biases.