Imagine two portfolios. Each compounds at exactly 8% per year over the long run. One delivers that result with steady consistency, year after year, without volatility. The other reaches the same average return through a far more turbulent path, marked by sharp gains and painful losses along the way.
If forced to choose and never allowed to change course, logic clearly favors the smoother ride. The return is the same, but the risk is lower.
Real investors, however, are not bound by such constraints. They can change their minds, and often do. That freedom is precisely where the trouble begins.
Even a theoretically perfect portfolio, if such a thing existed, would be difficult to hold. As markets rise, investors naturally zoom in on recent results. A volatile strategy that has outperformed for an extended period can become increasingly tempting, feeding the fear of missing out and the belief that strong performance will continue. When losses inevitably follow, the pendulum swings back. Fear replaces greed, confidence fades, and investors retreat—often just in time to miss the recovery.
Both design and discipline matter. Many investors devote considerable effort to constructing an optimal strategy but may underestimate the emotional challenge of sticking with it when markets test their resolve.
Investment decisions are shaped by a constant tug‑of‑war between two internal voices: reason and emotion.
Emotion is reactive and backward‑looking. It is driven by fear and greed, amplified by recent experience. After long stretches of strong returns, fear of missing out becomes dominant. After sharp losses, the instinct to protect capital takes over.
This emotional pendulum tends to swing most forcefully at precisely the wrong times. Near market peaks, when optimism is widespread and recent gains feel irresistible, investors may be inclined to take on more risk. Near market lows, often amid negative headlines, when valuations may be most attractive, fear tends to overwhelm logic and drives investors to reduce exposure.
Over time, this pattern leads many investors to repeatedly buy high and sell low—not because they lack intelligence or information, but because emotion can overwhelm discipline.
Markets are cyclical, even if the timing of those cycles is impossible to predict with precision. Periods of strong returns tend to follow extended downturns, while long bull markets often sow the seeds for the next secular bear market. Valuation plays a central role in that process.
One way to observe this relationship is through long term valuation measures such as the Shiller PE, which smooths earnings over a ten-year period and has data extending back to 1871. Over many decades, lower starting valuations have generally been associated with stronger long-term returns, while higher valuations have tended to coincide with more subdued outcomes.
This historical relationship becomes clearer when market outcomes are grouped by starting valuation levels. While the exact path varies widely across individual periods, the long-term pattern has been consistent.
| Starting Shiller PE Range | Subsequent 10 Year U.S. Large Cap Return (Annualized Range) |
| Under 20 |
3% to 19% |
| 20 to 35 | 0% to 17% |
| 35 and above | -3% to 5% |
This relationship is frequently misunderstood. Valuation does not tell investors when markets will peak or trough. Expensive markets can remain expensive for years, just as cheap markets can get cheaper before they recover. What valuation does provide is context. It shapes the odds.
For perspective, the Shiller PE stands at approximately 37 as of March 31, 2026, placing today’s market near the upper end of its historical range. Historically, environments like these have tended to be less forgiving, even though outcomes have varied widely and valuation alone does not dictate near term market direction.
When valuations are elevated, future returns are more dependent on continued favorable conditions and leave less margin for error. When valuations are depressed, expectations are lower and the range of favorable outcomes is broader. Recognizing this asymmetry can help investors avoid making their most consequential decisions at precisely the wrong moments.
The purpose of valuation, then, is not to override discipline or justify constant portfolio changes. It is to serve as a counterweight to emotion—particularly when fear of missing out or fear of loss is most intense. Used this way, valuation becomes less about prediction and more about perspective.
Emotional signals tend to intensify as market cycles mature. In extended bull markets, sustained gains reinforce confidence, extrapolation feels natural, and caution fades. Ironically, this is often when valuations become stretched and future expected returns decline. The strongest urge to buy typically arrives when optimism is already reflected in prices.
The opposite dynamic appears during market downturns. As prices fall and valuations become more attractive, fear and pessimism peak. The same instincts that once encouraged participation now demand retreat. Yet these moments of heightened anxiety are often when long-term opportunities quietly improve.
Recognizing this pattern is critical. The objective is not to eliminate emotion, which is unrealistic, but to understand when emotion is most likely to mislead. Markets will always provoke strong reactions. The challenge is learning when to question them.
One useful mental framework is to separate every major investment decision into two simple questions:
When those answers align, decisions tend to feel easy. When they conflict, which often happens at market extremes, it is usually worth giving greater weight to reason.
As a general rule, when enthusiasm is widespread and assets appear expensive, restraint may matter most. When fear dominates and valuations are depressed, patience and discipline in buying have often been rewarded. In other words, the strongest emotions to buy tend to coincide with elevated prices, while the strongest emotions to sell often emerge when prospective returns are improving.
Markets do not punish ignorance as severely as they tend to punish poor judgment under emotional pressure. The most consequential investment decisions are rarely made in moments of calm. They are made when confidence is high or fear is overwhelming. Investors who learn to recognize which internal voice is speaking, and resist purely acting on the loudest one, give themselves a quiet but enduring advantage over time.
Alex Shahidi is co-CIO and senior managing director at Evoke Advisors, a division of MAI Capital Management.
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