It's not exactly a secret that emotion-based investing isn't the path to building a rock-solid portfolio. But is there a concrete, identifiable cost to buying stocks based on how you feel? In this segment of Backstage Pass recorded on Jan. 26, Fool contributors Rachel Warren, Jason Hall, and Connor Allen discuss what investors need to remember about emotional investing during volatile market times. 

Rachel Warren: I think it's something that's important to talk about because we do see I think a lot of the volatility that we're also seeing is a clear sign that a lot of investors are emotional right now. While that's not a way to invest effectively as a long-term investor, we still see that that's playing a big part in some of the actions that we're seeing in the market.

So I would say, just for my own point of view, I think long-term investors that have stable, forward-looking mindset, you can capitalize on this reality, knowing that some investors are going to be investing emotionally, that that's going to, in some cases, drive stock prices down.

That gives you an opportunity as someone with a long-term, forward-thinking mindset to get those quality stocks on sale while staying invested in the market through the tough times.

Something I've said before and I feel like a broken record, but I'll say it again, is you've only actually lost real money if you sell those stocks. For example, I look at my portfolio today and some of my favorite stocks have plunged into the abyss, at least temporarily, but I'm not selling them right now. That money to me isn't actually lost, it's just down temporarily.

What I've seen a lot lately, which I have found really an interesting reinforcement of this example is that one day I'll have a stock like Shopify, I'll get a notification it's down 5% today. Well, the next day it's up 5%.

So it's this constant back and forth, but I'm just staying invested, I'm not touching that investment. If anything, once I stopped talking about it, I'm going to add to it because I think now is a great opportunity to do so. So it's a helpful reminder as well.

One thing that I was curious about was sometimes we look at what is the actual outcome of emotional investing. I actually found some data about this that was released by a firm called DALBAR a few years back.

Jason Hall: DALBAR is great. I know what you're--

Rachel Warren: Yeah.

Jason Hall: I think it's like 39 years they've done this report.

Rachel Warren: Well, on this report, the most recent one I found was from a couple of years ago, but yeah, you guys feel free to weigh in after I read this data if you want.

But what was interesting was the report said "the nation's leading investor behavior study over the last 25 years found that the average investor took some money off the table", and this was in 2018, "but was still poorly positioned for the second half of the year. The average investor was a net withdrawer of funds in 2018, but poor timing caused a loss of 9.4% on the year compared to an S&P 500 Index that retreated only 4.38%".

What was interesting as well, there was a quote in here from the Chief Marketing Officer at the company, he said, "Judging by the cash flows we saw, investors sensed danger in the markets and decreased their exposure but not nearly enough to prevent serious losses. Unfortunately, the problem was compounded by being out of the market during the recovery months. As a result, equity investors gained no alpha and actually trailed the S&P 500 by 504 basis points."

Just looking at those numbers, you see when you look at the actual data, there is a true cost to trying to time the market and you will very likely miss out on those recovery periods.

Jason Hall: Rachel, that's from DALBAR's QAIB, their quantitative analysis of investor behavior.

Rachel Warren: Yes.

Jason Hall: It is an incredible long-term study that they've been doing, and I think it's one of those things where it's a reminder that there is what the market does and then there's what investors do.

This is just such a good long-term reflection of that, but it goes even further because it looks like investors in funds and different asset classes and that kind of thing get some really deep data. But there's an interesting thing that's even older than the DALBAR study and I wondered this might have actually inspired some of the DALBAR's research Peter Lynch.

Peter Lynch, I think it's fair to say, is probably the best, the most successful investing fund manager of a retail product that everyday investors can invest in ever. He generated like almost 30% annualized returns for 20 years.

His track record is absolutely remarkable. But from what I've seen in the past, I don't know if it's completely true or accurate, but the average investor in The Magellan Fund while he managed it trailed the S&P 500.

Rachel Warren: Wow.

Jason Hall: Because you know what happened? It had a great year and it was a slow news day and somebody would write an article about Peter Lynch, and it would show up in the paper or he'd be on something on NBC Nightly News or something like that or whatever.

This is before the internet. Anyway, people would read that, they pile into the fund, and then something would happen, the year would start off bad and they lose money, and they'd run for the door. Try to buy high and they'd sell low.

It emphasizes all the things we talked about about mindset. I think that's the thing about it, is you can have the best stock picks in the world, you could sign up for Stock Advisor and all of the Everlasting services and Motley Fool One and get the best information in the world.

But if you can't manage the gray matter in your brain, align the incentives to your time frame, and have a process, you are still going to screw it up because you're going to get your own way. That's just what happens.

Rachel Warren: Yeah. Go ahead.

Connor Allen: Everyone thinks that the reason people trail the S&P 500 is because of bad stock picks, and I just don't think that's very accurate at all. It's because they're not spending enough time in the market and they are trying to get in and out, just like what you're saying.

Rachel Warren: Oh, yeah.

Jason Hall: 100% Connor. 100%. 

Rachel Warren: Well, and I think when you see it quantified in those real-world numbers, it puts a number on it, which I think is a lot easier than trying to just have the mindset when you understand the numbers behind it that can also help as well.