Do happy people make better investors?
We know that people often behave irrationally—taking the market’s recent performance and projecting it forward. Depending on whether it’s up or down for the last 12 months, people either think that we’re headed upwards towards a glorious bright-and-shining future or a dismal, grey doom. But do our moods affect our investment decisions?
Interestingly, the answer appears to be yes. Investor sentiment is generally a contrary indicator—when other investors are overwhelmingly bullish, people need to be careful. Conversely, when everyone else is gloomy, it’s time to aggressive. “The time to buy is when the blood is running in the streets,” as Lord Rothschild put it.
But investors need to watch out for their own moods. A recent study evaluated a host of factors to see if they had an impact on investment decisions. Notably, a person’s general outlook on life, the recent performance of their favorite sports team, and the weather—especially if they suffer from Seasonal Affective Disorder—all had a significant effect on their expectations of market risk and return. Notably, when people were happier, they tended to be more aggressive in their market expectations—looking for higher returns with lower risk.
Return expectations vs. Mood. Source: JFQA
This is important. If we’re overly optimistic, we might take more risk than we should. We could end up selling stocks or bonds at just the wrong time—turning a temporary market fluctuation into a permanent loss of capital. On the other hand, if we’re too cautious we won’t take the risk that we need. Our portfolios won’t grow enough to meet our future needs.
So watch out when you root for your favorite football team or if the short winter days start to get you down. It’s okay be a little blue, or to cheer for the Pats. Just remember: the market doesn’t care how you feel. Future earnings discounted to present value aren’t determined by our moods.
Douglas R. Tengdin, CFA
Chief Investment Officer