Investing can be an emotional business. When stocks are soaring, greed can take over and create the temptation to buy and make more money. When stocks fall, fear can set in and create the temptation to reduce losses and sell.
Most financial experts will advise investors to stay the course during periods of market volatility, remain invested and don't try to "time" the market -- buy at the low and sell at the high - because no one knows for sure when those lows and highs will come.
A common and sound principle says that what's important in investing is not timing the market but the amount of time invested in the market.
In the second of a series of reports by BMO Bank of Montreal that examined the mindset of Canadians when dealing with the personal finances, 40 per cent said that emotions play a role in their investment decisions. Nearly 60 per cent of Canadians admit they have invested on impulse at least once, two thirds have not been in total control of their emotions when investing and only 16 per cent are very familiar with the actual investment they hold in their portfolios.
"While we're only human, wise investing means more than simply following your heart," says Serge Pepin, vice president of investment strategy with BMO Asset Management. "It's critical not only to take the time to understand the market environment before making any financial moves, but also to ensure you're in the right frame of mind to make such decisions."
In the survey, 40 per cent of Canadians said they are not confident when investing. Only 25 per cent do careful and extensive research before making investment decisions and 35 per cent admitted they are not even familiar with the companies in which they have invested.
"Reading the business pages of newspapers and magazines, doing research online and seeking advice from financial professionals can help to ensure an informed investment decision-making process," Pepin says.
There are several ways investors can help to manage their emotions and hopefully make good, rational investment decisions.
Perhaps the most important is to know yourself. "From the novice to the professional, it's important to take time to understand what you want to achieve," says Pepin. "Know what you're goals are and what your risk profile is and then make sure your investments are right for you based on your profile and goals. Sitting down with a professional can really help you determine what those are."
There are some technical vehicles which can give investors some clues about investor confidence and how markets might perform in the future such as the Chicago Board Option Exchange VIX index and the Montreal Stock Exchange MVX index which measure the volatility of stocks in the coming 30 days.
Sometimes referred to as the investor fear gauge, the VIX has become known as the premier barometer of investor sentiment and market volatility.
There are three variations of volatility indexes. The VIX tracks the S&P 500, the VXN tracks the Nasdaq 100 and the VXD tracks the Dow Jones Industrial Average.
The lower market volatility is, as measured by VIX, the more likely investors are to be complacent. The reverse also is true. When volatility spikes higher, investors tend to be more nervous and wary of committing their capital to what they may view as a riskier asset class.
A study of VIX over many years has found that returns in the market increase with volatility. High volatility periods were followed by average monthly returns of 6.3 per cent for S&P 500 stocks. In contrast, low volatility periods were followed by average returns of only 5.4 per cent over the following six months.
"The VIX and MVX may be good indicators, but they are just that - indicators," says Pepin. "They may be a signal of where the markets are going but you really need to look at as many factors as you can. Looking at just one could steer you in the wrong direction."
Regardless of volatility measurement tools, investors still have to come to terms with the amount of risk they are willing to accept and should return to the principle of asset allocation - investing over different markets and asset classes to maximize potential returns and minimize risk.
"Start with a solid base of good, sound investments and then use what's left to take advantage of opportunities as they arise," Pepin says. "And meet with an advisor periodically to make sure your portfolio continues to meet your goals. Life and events change over time and you may need to tweak your investments to meet your current situation and needs."
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.
