The average investor consistently underperforms the market. According to Dalbar’s Quantitative Analysis of Investor Behavior, the average equity investor returned 7.13% annually over the past 20 years while the S&P 500 returned 10.5%.
This 3.37% annual gap isn’t due to fees or taxes. It’s due to emotional decision-making.
The Fear-Greed Cycle
Human emotions follow predictable patterns that consistently damage investment returns:
Greed drives buying at peaks. When markets are rising and everyone feels wealthy, investors pour money into stocks at precisely the worst times. The technology bubble of 2000 and the crypto mania of 2021 illustrate this pattern perfectly.
Fear drives selling at bottoms. When markets crash and losses mount, emotional pain becomes unbearable. Investors sell their holdings at exactly the moment they should be buying more.
Regret fuels poor decisions. After missing gains or realizing losses, investors make increasingly desperate attempts to “catch up” or “get even.” This leads to speculation, excessive risk-taking, and further losses.
Why Smart People Make Dumb Investment Decisions
Intelligence doesn’t protect against emotional investing mistakes. In fact, smart people often make worse investment decisions because they:
- Overconfident in their ability to time markets
- Create complex narratives to justify emotional decisions
- Believe they can outsmart systematic approaches through analysis
- Ignore objective evidence when it conflicts with their beliefs
Successful investing requires acknowledging that emotions will influence your judgment regardless of your intelligence or education.
The Discipline Solution
Systematic approaches work precisely because they remove emotional decision-making from the investment process. When you follow predetermined rules, you can’t second-guess yourself into poor choices.
Consider the difference between these approaches:
Emotional approach: “The market looks scary right now. Maybe I should sell my stocks and wait for things to calm down.”
Systematic approach: “My stocks are still in the Buy zone according to my system. I’ll hold until the system signals otherwise.”
The first approach feels comfortable in the moment but typically produces poor long-term results. The second approach often feels uncomfortable but produces superior returns over time.
Building Emotional Discipline
Systematic investing isn’t just about having better information or superior analysis. It’s about creating structure that prevents emotional interference with sound investment decisions.
The most successful investors aren’t those who feel no emotions—they’re those who don’t let emotions drive their actions.
This requires accepting that you’ll sometimes feel uncomfortable following your system, especially during volatile periods. That discomfort is usually a sign that the system is working correctly.
Tomorrow, we’ll explore the mathematical evidence supporting systematic approaches over emotional decision-making.