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DOLLARS & SENSE

The psychological pitfalls of investing –

and how to avoid them

The low volatility era came to a sudden halt in February, but with economic momen- foretell the future, among other things. If you find yourself confidently declaring
tum still strong in major regions around the globe with both corporate earnings and that you “knew it all along” ask yourself whether you really did. As with optimism
guidance robust, markets still have some growth left and we give equities the benefit and over confidence, you may have to consciously compensate for hindsight.
of the doubt. While we are mindful that the business cycle is very much maturing this 4. Obsession
provides investors the opportunity to review their current portfolios and ensure their
tolerance for risk reflects their current portfolio. Do you follow the performance of your investments minute-by-minute on TV or the
Internet? Do you dwell on short-term changes in the market value of your invest-
Below are 7 simple areas that you should consider when the volatility increases to ments? Do you fixate on the negative performance of a single investment, even
be sure you are prepared and don’t make the common mistakes investors make in a when your overall portfolio is doing well? These can all be signs of obsessive be-
market downturn. havior commonly displayed by investors.
Do you get anxious when the stock markets are volatile- or absolutely indifferent Take a step back and look at the big picture. Are you on track to achieving your
both natural parts of your psychological makeup and both can actually impede your longer-term goals? Are you comfortable with the level of investment risk in your
progress towards your investment goals. portfolio? If not, you may have to make adjustments to stop obsessing about short-
term events.
The good news is that you can gain some control over your psycho- 5. Denial
logical responses by understanding some of the common challenges
of investing and creating a more solid strategy. Following are seven When stock markets go down, investors can sometimes panic and
psychological pitfalls of investing – and how you can avoid them. sell what is still fundamentally a good investment. The flipside of
this is denial – when investors continue to hold an investment that
1. Optimism has gone bad, thinking it will eventually come back. It can be hard,
People have a natural tendency to overestimate the likelihood of posi- but when an investment has fundamentally deteriorated, it may be
tive results on everything from the weather to investing. This largely time to sell. Having an investment discipline/Investment policy in
explains why people are so often disappointed by their investment place with specific, rational criteria for buying and selling can help
performance – they simply felt they would do better based on this you overcome this tendency.
psychological bias. 6. Greed
Avoiding the feeling of disappointment is only one good reason why The desire to “get rich quick” compels many investors to take big-
you should consciously compensate for this natural optimism. If you ger risks than they should or need, such as investing too much in a
base your financial goals on unrealistically positive expectations, single investment. When the risk doesn’t pay off, it can jeopardize
you will almost certainly fall short of these goals. Goals that are rea- Erica Tennenbaum, CFP, FCSI their financial security. That doesn’t mean you should never take
sonable allow for your goals to be achieved and your retirement date, a risk – it’s a normal part of investing. The key is to take well-
expected income can all be based on a realistic number. Numbers Vice President & Wealth Advisor calculated risks within a properly diversified investment portfolio,
that provide for market downturns in your plan take some of the which is designed with your personal risk tolerance in mind. That
emotion out of investing. way, when the occasional risk doesn’t pay off, the impact is mitigated by the other
investments in your portfolio.
2. Overconfidence
Another powerful psychological bias is overconfidence. Just as people tend to be 7. Herd instinct
overly optimistic about the probability of positive results, they also tend to be over- When we see other people doing something, we have a natural tendency to think
confident about their own talents. Some investors think that they can “outsmart the that it must be a good thing and we should do it too. This “herd instinct” is often
market” – and even control largely unpredictable events such as stock market volatility. behind sharp ups and downs in the financial markets. When other people are buy-
ing, propelling the market upwards, we buy too, sending the market even higher.
This leads to one of the most common pitfalls of investing – market timing. Confi- Similarly, when other people sell in a panic, sending the market downwards, we sell
dent in their own abilities, many investors try to time the market so that they always too, fueling the decline. Unfortunately, this often results in buying at the height of
buy low and sell high – despite the fact that not even the most accomplished profes- the market euphoria, or selling close to the depths of the panic. Instead of following
sional investors can do this consistently. the herd, follow a disciplined investment strategy based on logic and reason.
Recognizing this tendency towards overconfidence is the first step towards dealing
with it. Try to be honest about your abilities, and if you find yourself falling into traps In summary, successful investing over the long term is less about how the markets
such as market timing, take a step back and rethink your approach. are doing than how we react to what the markets are doing. Unfortunately, many of
our natural psychological reactions – like denial, panic or greed – can impede our
3. Hindsight long-term success.
Hindsight is the tendency to believe that after something has happened, you knew all Erica Tennenbaum, CFP, FCSI, Vice President
along that it would – even though you didn’t. This tendency can lead you to believe Associate Portfolio Manager and Wealth Advisor
that events are far more predictable than they really are, raising unrealistic expecta- RBC Wealth Management
tions about how well your investments will perform and your advisor’s ability to www.ericatennenbaum.com

Professional Wealth Management Since 1901

This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered
properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor
its employees, agents, or information suppliers can guarantee its accuracy or completeness. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities
Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business
segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under licence. © 2018 RBC Dominion Securities Inc. All rights reserved.
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Spring 2018