Managing your emotions during volatile stock markets

If you’ve watched television or read a newspaper lately, you’ve seen the headlines: “Stock market volatility has everyone on the lookout” or “Stop this stock market ride. I want to get off!”

Stock markets have been on a roller-coaster in 2022, largely due to concerns about the impact of rising inflation, fears of a possible U.S. recession and geopolitical conflict such as Russian President Putin’s invasion of Ukraine.

It’s enough to give investors whiplash.

These recent market gyrations also have investors wondering whether the return of volatility is a short-term hiccup or the new normal, and whether they should make major changes to their portfolios.

Volatility is tough to stomach, but investors should keep market movements in perspective. Since the “COVID Crash” of 2020, the S&P/TSX Index climbed steadily from of low of 11,228.50 on March 23, 2020 to a high of 22,087.20 almost exactly two years later, on March 29, 2022. That climb – nearly 200% – lulled many investors into complacency. In fact, the volatility we’ve experienced recently is normal in terms of historical market behavior – the long-term market trend is up, but along the way there have been periods of volatility like this.

In times like this, it’s important not to let your emotions dictate your actions. Remember, as your advisors, we’re here to help you put market volatility into perspective and stay on track to your long-term goals.

The pitfalls of investor psychology – and how to avoid them

Experienced investors understand, intellectually, that market corrections are a natural part of the investment landscape, and that they should look beyond the headlines for guidance. Yet humans are emotionally wired to desire more of what gives us pleasure and less of what gives us pain. These crosscurrents often clash when we invest.

Certain behaviors — such as selling stocks during a market downturn — create “return gaps.” A return gap reflects the difference between the average return for a fund or index and what the average investor earned within the same investment.

That gap exists because that average investor, concerned about market corrections, often will pull out of the market, missing the recovery period and the ability to increase their return.

Even after crafting a personalized investment approach and financial plan, some investors can react in the moment or adhere to long-held beliefs that may undermine returns. Those factors, called behavioral biases, are subconscious tendencies that drive an otherwise rational person to act irrationally.

Here are several common behavioral biases that can affect investment decisions:

• Belief in being “above average”: Overconfidence leads investors to believe that they’re a stock picking genius when an investment performs well. But when that investment sinks, those investors blame the drop on “the market” rather than admitting that they are below-average at stock picking.
• Following the crowd: When the larger group does something, like buy a “hot” stock (think internet stocks in the late 1990s), or sell in a panic when the market drops, others follow suit. Avoiding the herd is one of the best things you can do for your own finances.
• The pain avoiders: People tend feel the pain of a loss about twice as much as the pleasure of the same-sized gain. In other words, some investors prefer not losing $100 versus gaining $100. This “aversion to loss” sometimes causes investors to make poor decisions during market downturns.
• Selective confirmation: Some investors seek information that confirms their idea about an investment rather while avoiding information that contradicts it. This confirmation bias can result in faulty decision-making because one-sided information leaves investors with an incomplete picture of the situation.
• Hindsight is always 20/20: Hindsight bias causes investors to believe, after the fact, that an event was predictable and completely obvious, whereas the event could not have been reasonably predicted.

As humans, most of us have these biases, and the first step is to better understand them. The next step is to manage them, which you can do through discussions with us as your advisors about market expectations and periodic reviews of your goals, time horizon and risk tolerance.

Take action to help protect your portfolio

Issues like the state of the market — whether a bull market or bear market — are not in the investor’s control. However, investors do have some opportunities to manage downside risk.

These three time-proven strategies can help keep you on track regardless of market movements:

1. Review your risk profile

You may find that both your ability and willingness to handle market swings varies over time. That’s natural, and it’s important to acknowledge your change in attitude so you can adjust your plan if needed. At the same time, don’t overdo it. Keep in mind that you will likely live in retirement for 25 years and that you’ll need some growth-oriented investments in your portfolio to achieve your retirement planning goals.

2. Maintain appropriate diversification

You can help reduce the impact of volatility on your portfolio by owning a mix of equities, fixed income and cash, diversified across different geographic areas and industry sectors. This helps reduce the risk from any one investment and shores up your portfolio against market volatility. It’s important to understand that diversification is not a one-time thing. We’re here to help you maintain the right level of diversification for you, based on changing market conditions and your evolving needs over time.

3. Stick to the plan – but keep it current

Simply having a plan, and knowing you have a destination, can help keep you on track during volatile markets. Your plan outlines your goals, objectives, time horizon and liquidity needs, and is designed for various market conditions. But things can change, and it’s important you keep us up to date, so we can help you adjust your plan if needed.

Don’t jeopardize your long-term investment strategy out of fear that a few bad weeks or months in the market will persist. Put simply, having a plan in place for what happens next builds confidence — and gives you the ability to look past today’s headlines.