Cycle of investor emotions
Ride the wave
When things are great, we feel that nothing can stop us. And when things go bad, we look to take drastic action. Because emotions can be such a threat to an investor's financial health, it is important to know how to keep your head above water in the cycle of investor emotions.
Click on an emotion to learn more about how it affects investment choices.
Investors typically start with optimism, which sits at the inflection point on the emotional upswing. We commonly expect things to go our way, or we expect to receive a return for the risk of investing. We go into the markets because we believe we will be able to grow our wealth through our investment choices.
When markets move in the direction we had hoped to see, we start to get excited about the possibility of even greater gains.
When the momentum continues, we find the experience thrilling and begin to anticipate even higher returns.
As markets reach the top of the cycle, investors may experience euphoria. We start to think that we made a smart move to invest when we did, and we believe that the good times will continue unchecked. We may even fool ourselves into believing we can tolerate higher levels of risk—and may begin to trade more frequently or invest in riskier asset classes.
The second phase of the cycle occurs when the market starts to turn. At first, we watch to see if the downturn is just a blip. We may believe that things will improve shortly and therefore hang on to our investments.
As the markets continue to fall, denial gives way to anxiety. Investment values decline perhaps even to the point that we begin to see losses. Reality sets in that maybe we weren’t as smart as we thought.
When market losses accelerate, real fear kicks in. Some investors may then turn defensive and switch out of riskier equities to more defensive equities or other asset classes such as bonds.
In the third phase of the cycle, the realities of a bear market come to the fore and an investor may become depressed and desperate.
Many of us missed our chance to take profits, and we may try to get our positions back into the black by either selling our worst-performing investments or moving into securities that don’t fit our risk profile. When that doesn’t work, panic sets in.
At this point, we feel at the mercy of the market and some of us pull out altogether, abandoning investments at precisely the wrong time.
Those who remain invested may become despondent and wonder whether they should ever have invested their hard-earned money in the markets.
In the fourth phase of the cycle, investors may experience some skepticism when markets start to rise. We often have a sense of caution or worry, wondering if market growth will last.
Though investors are hopeful about continued market increases, we may still be reluctant to invest money—even at a point when prices are still relatively low and opportunities are attractive.
Eventually we come to realize that the market is recovering. For those investors who let their emotions rule their investment decisions, the market cycle can begin all over again.
*Magnificent 7 refers to Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla and Meta as the largest market cap stocks.
For illustrative purposes only. Latest month-end data as of December 31, 2023. Market cycle returns calculated using Ibbotson U.S. Equity Total Return Index from 1971-1978 and Russell 3000 © Index from 1979 to 2023. In USD. Source for market events: Russell Investments. Indexes are unmanaged and cannot be invested in directly. Past performance is not indicative of future results.