Overcoming the fear factor

I recently had a conversation with my niece about her savings plan and where she planned to put her money. I expected the conversation would be around the TFSA vs RRSP debate, but she was actually much more concerned about whether or not she should invest her money in the market at all. Some of the Investments she made last year had fallen quite a bit and she was nervous about adding more. It’s understandable. Investors across the board had a difficult year in 2022 as both equity and bond markets experienced a steep sell-off. In fact, investors in balanced portfolios had one of their worst years since the 2008 financial crises and 2022 ranked as one of the top 10 worst years for balanced portfolios in the last century.

I didn’t want to give her too much direction about how she invests her money, but I did want to remind her that investing at least some of her money in equities as a long-term investment historically provides better returns than staying in cash. However, following her first time experiencing a bear market, I understand why she would be hesitant to put more of her savings into the market. I recall being nervous and second-guessing myself following some of the large market drawdowns I experienced over the past few decades like the dotcom crash of 2000, the financial crises of 2008 and even the brief covid crash in early 2019. While these market events are to be expected, they can be unpredictable and often leave emotional scars that can affect our investing behaviour.

Loss aversion

One of the key insights from the study of behavioural finance is the ‘loss aversion principal’. It states that losing money or even potentially losing money is much more emotionally painful than the joy we receive from gaining the equivalent amount of money. This fear of loss causes investors to behave irrationally. While its completely understandable, it’s important for investors to be aware of their own biases so that they can overcome the fear factor.

The benefits of staying invested

One of the general rules of thumb for investing is that it is better to stay invested over the long term rather than trying to time the market. The goal is to stay focused on your long-term financial goals and do your best to ignore the short-term volatility of markets. The magic of compounding returns only works if you remain invested over a longer time-horizon.

To put that in context, a few years ago when Fidelity Investments did an internal review of their own customers to see what type of investors had performed the best, they found a surprising result. Investors who had forgotten their account password had the best performance. This is because they were forced to stick with their investments (even if by accident) rather than buying and selling based on short-term market fluctuations. Sadly, despite our best efforts, we often manage to buy high and sell low because we are motivated by fear.

The benefits of starting young

When it comes to investing and saving, one of the biggest benefits my niece has going for her is that she is in her early twenties. Starting early and letting your investments grow through compounding interest is something investors sadly really can’t make up for later in life. If you start investing in your 20’s, by the time you are 65, over 50% of the value of your portfolio will come from the money invested in your 20’s. This animated chart from visualcapitalist.com helps put that in perspective. The Ontario Securities Commission’s compound interest calculator is a great tool to help investors understand the value of compounding returns.   

Re-assessing your risk tolerance

All these golden rules of investing are important, but if you can’t sleep at night, you might be taking too much risk. The steep market drops during the 2008 financial crises caused me to re-assess my risk tolerance. Of course, I had taken account of my risk tolerance when I started, but your risk tolerance can change over time. In theory I was quite comfortable taking on risk because I knew it also led to better potential returns.  In practice though, seeing my portfolio value drop sharply in a short period of time changed my perspective.      

I believe DIY investors could especially benefit from re-assessing their risk tolerance since data shows that many of them only started on their investing journey recently. Surveys from the OSC and JD Power also show that DIY investors tend to be much less risk-adverse, as they are more willing to buy crypto, individual stocks and high growth funds. Some interesting datapoints about DIY investors include:

• Only 50% of Canadian self-directed investors have held their self-directed account for 5 years or more and 10% of investors opened their account during the pandemic.[i]
• Only 14% of self-directed investors consider themselves to be “conservative”.[ii]
• 37% of Canadian millennial self-directed investors hold cryptocurrencies.[iii]

My advice to my niece and to the many new investors who may have experienced their first bear market is to keep investing, sick to your long-term plan, but ensure that you are taking the appropriate amount of risk based on your risk tolerance. Don’t be afraid to re-think and make changes to your plan along the way, it is a long journey ahead.

Christine Zalzal
Senior Vice President & Head of Online Brokerage and Digital Wealth
Aviso Wealth