Happier clients are more optimistic and willing to take risks -- even if they shouldn't.

Do investors’ moods affect their investment decisions?

According to Guy Kaplanski, a business professor at Bar-Ilan University in Ramat Gan, Israel, an individual investor’s mood can have an important impact on their investment judgment and their attitudes toward reward and risk expectations — in the short term, anyway.  

People who are in a good mood tend to be more optimistic about the market, he says, whereas those who are down are more likely to have a negative view of the market.

Previous research has shown that there’s a correlation between seasonal affective disorder (SAD) and market patterns. On an aggregate level, “studies have shown that markets are particularly going down in the autumn,” Kaplanski says, “but it’s difficult to prove whether this is due to personal depression – the winter blues – alone or whether it’s also related to something that is happening economically, whether it is probability or coincidence.”

In his latest study, entitled “Do Happy People Make Optimistic Investors?” Kaplanski shows a personal link between moods and market movements by boiling things down to the level of an individual and his or her particular frame of mind at different moments in time.

Over the course of one year, his team surveyed a few thousand individual investors in Netherlands to gauge their moods at different points in time and how their moods impacted their views on financial markets. Participants were asked simple and direct questions, “like what is the weather, what’s the date and the time, how do you feel right now, are you under pressure, are you in a great mood or a bad mood,” according to Kaplanski.

He said: “We found there was a direct link between the answer to their questions and their view of the S&P 500 and their home market, Netherlands. If someone was in a not great mood, then they were pessimistic about the markets. If they were happy, then they were optimistic about the markets.”

Kaplanski says that events like the victory or loss of a favored sports team also impact individual investors’ mood and their subsequent outlook for the market, but again, only in the short-term. In the longer term, he says, investors seem to be more rational and take better decisions vis-à-vis their investments and the market.

“There’s more noise in the long-term, and people tend to think about the longer term in a more complex and professional way,” he says. “The good news there is that when investing for the longer term, the outlook on markets is such that people seem to make fewer mistakes than they do in the short term.”

For advisors, working through short-term mood swings and ensuring they don’t influence a client’s investment decisions can be a bit of a challenge.

“When you’re sitting down with someone, you are probably getting answers that depend on their immediate mood,” Kaplanski says. “This is particularly important for an advisor studying a client’s risk appetite: Beware that someone could be more open to risk because his sports team just won a big game, and he may then want to make the kind of investment that he could regret in the future.”

To the extent that it’s possible, it’s important for an advisor to make sure that his or her client is in a “normal” mood, and not affected by any short-term event, mood swing or personal situation that could cause a different way of thinking about the market. Those are the worst times, Kaplanski says, in which to make a financial decision.

— Read Investors Becoming More Tolerant of Market Volatility: MFS Survey on ThinkAdvisor.