There is a reason why the normal ups and downs of the stock market can leave you depressed, writes Peter Watson.
It has to do with human behaviour. People are emotional.
Investors value gains and losses differently. A loss has more significance on an investor than a gain of an equal amount.
For example, if for one month half the days your portfolio increases in value and the other half it decreases in value by the same amount, then what is the result? Based on the arithmetic, nothing has changed.
However, from an emotional perspective you have suffered because the days your portfolio declines in value are more difficult on you emotionally. If during this period of volatility stock prices decline in value your emotional suffering will be enhanced.
Understanding emotional behaviour has become an important part of understanding human behaviour when we invest. Prof. Daniel Kahneman, a psychology professor at Princeton University won the noble prize in Economics in 2002 for his contribution to behavioural economics.
Kahneman’s research includes the “loss aversion theory.” That is the bases of what is described in this column.
An important question is how can this understanding assist us with our own personal investing?
We should appreciate the reality that we are subject to emotional reactions when investing. If this is understood, it can prepare you for the times your nerves might be on edge during a volatile or declining market.
That will not necessarily dictate how you react during volatile times, but we would hope it would inform any decisions you make.
Peter Watson is registered with Aligned Capital Partners Inc. (ACPI) to provide investment advice. Investment products are provided by ACPI. ACPI is a member of the Investment Industry Regulatory Organization of Canada. The opinions expressed are those of the author and not necessarily those of ACPI. Only investment-related products and services are offered through Watson Securities of ACPI. Peter Watson provides wealth management services through Watson Investments. He can be reached at www.watsoninvestments.com
